Joe, I am going through this process now, and it hit me that there potentially a better way to explain this, than was previously stated. And remember that I am a Business Broker and not a CPA, so this is more common sense (I hope) than a product of GAAP approved practice.
Part of the diffculty is knowing that Cash Flow, as a label in the way it is being used here, is a misnomer. The more correct term should be SDC, or Seller's Discretionary Cash. And this applies to small business, rather than large corporations. Keep in mind that the average small business Owner, to some degree or another, uses his (or her) company as an extension of his checkbook. A major reason for this, they claim is to reduce Tax Liability. That means that there are far more potential "adjustments" or "add-backs" to EBITDA than the large corporation might experience. (You don't normally find a major, public company CEO using company money for personal gain, unless you are the CEO of Tyco and are desperate to buy a $7,000 shower curtain...but I digress...)
For small businesses, SDC would include EBITDA, in many cases plus any additional one-time expenses. If, for example, the Seller put up walls in the office and wrote it off at once, reather than depreciating it, that might be added back. It is a one-time expense that you, as the Buyer would not need to spend money on, in successive years. If a restaurant Seller is taking home $100 a week in "personal use" goods, a Seller, his Broker or his Accountant might also want to add that back. It is legitimate, but how do you prove it?
Another example of a legitimate adjustment is with a manufacturer I once represented. I questioned the amount and distribution of Salaries. He said his grandchildren were on the payroll. I wanted to know if they planned to stay with the company, or whether they needed to be replaced; I asked what roll they played and he said, "Just that; they play." They were 5 and 7 years old, and this was his way of funding their college plans. Those amounts were legitimately adusted by adding them back into the EBITDA. I have no idea whether this was a sound Tax strategy on his part, but it was what he wanted to do. This is where the "D" or "Discretionary" part of the SDC comes in: It is up to the Small Business Owner's Discretion, as to how some of these funds are spent. In another situation, I sold a very large Deli, and the Deli's son was earning $75,000 per year - to make corned beef sandwiches! He was not managing anything. At that time, I know the Seller could have replaced his son with a $6 per hour worker, but that was his discretionary decision.
The problem with some of this is that some Sellers, Accountants and (yes,) Brokers use too much "discretion". That is why I said in my prior comments that SDC or "Cash Flow", as it is used in this environment, needs to be used carefully, and only as a barometer - not as gospel! If you are given a Cash Flow or SDC number, ask for a detailed explanation of the adjustments. You can usually see what is rational and what may be bogus. And even if it is rational, just like the example above with "personal use", is it traceable?
I hope this is clearer.