EBITDA Versus Reality │ Canada
Peter A. Saad of Loopstra Nixon LLP outlines how EBITDA figures can sometimes create more questions than they answer.
Getting an accurate picture of a company’s true financial performance and health is often a challenging task – one that can be made easier and more transparent with the use of accounting standards, such as those included in the widely used International Financial Reporting Standards (or “IFRS”) and Generally Accepted Accounting Principles (or “GAAP”).
These practices can help standardise, compare, and create a baseline for assessing a company’s financial reporting.
Enter EBITDA
However, Earnings Before Interest, Taxes, Depreciation and Amortization (or “EBITDA”) is an alternative: a particularly popular and frequently used financial reporting tool utilised by companies around the world – in various forms – to assess and present a company’s financial health and performance (albeit one that is not recognised by GAAP).
EBITDA has gained in popularity over the decades as a way of measuring a company’s cash flow by excluding non-operational expenses and other factors that might misrepresent a company’s profitability. EBITDA provided analysts and investors with a standardised figure with which they could compare the financial performance of companies more easily, particularly in sectors where companies often have differing capital structures or are at different stages of development.
Adjusted EBITDA
It is also extremely commonplace for companies to adjust their EBITDA figures in an effort to present a clearer, undistorted – or sometimes more positive – image of their financial performance; one that is unaffected by factors like one-off payments, and irregular gains and losses.
"Care should be taken to understand exactly what the EBITDA figures include and exclude."
These types of “adjusted EBITDA” figures are frequently used in the business world (one has only to look at the financial reporting by some of the world’s largest blue-chip companies to see examples) and can often present a myriad of complexities, so care should be taken to understand exactly what the EBITDA figures you are looking at include and exclude.
Adjusted EBITDA typically makes additional adjustments to the standard EBITDA figure in order to reflect specific items that are considered unusual, one-off, non-recurring, or non-cash. These adjustments can vary depending on the sector, company type, and situation, but common examples include:
- Non-recurring or one-off expenses and payments: Adjusted EBITDA can sometimes exclude expenses and payment that are not expected to recur in the future, such as costs and payments associated with M&A, restructuring and employee terminations; litigation settlements; special donations; insurance pay-outs; and legal fees.
- Non-cash charges: Non-cash expenses (ie, write-downs or accounting expenses that do not involve a cash payment) might be excluded from a company’s EBITDA figure, as they might not directly affect a company’s cash flow.
- Stock-based compensation: Similarly, certain equity-based compensation provided to employees (ie, stock options) is occasionally excluded from adjusted EBITDA, as a non-cash expense.
In Practice
Adjusted EBITDA figures are used by companies for a range of purposes and are calculated using a variety of methods. External analysts and observers may also arrive at different adjusted EBITDA figures due to differing methodologies, assumptions and timeframes. As such, it is important to take the time to understand what has been factored into any EBITDA or adjusted EBITDA numbers and what has not.
EBITDA and You
When looking at any EBITDA figures, buyers and their lenders in particular should make special efforts to do their due diligence thoroughly in assessing prospective targets before any agreements or contracts are signed. It could mean the difference between an attractive deal and a disastrous one.
While EBITDA and adjusted EBITDA can be useful metrics for evaluating a company’s performance, operating profitability and cash flow, they are not tools that easily allow a straightforward comparison of businesses, in many instances. Therefore, it is important to use these figures in conjunction with other financial assessment tools, in order to get a more complete picture of a company’s financial health. As mentioned, EBITDA figures can differ from the reality of a company’s financial performance in a great many ways, and asking the right types of questions can potentially save the day.
Loopstra Nixon LLP
