EBITDA For Dummies

Email agenda:

Estimated read time: 5 minutes 35 seconds

1. EBITDA and why it's so important

2. Adjusted EBITDA -> what companies bid on

3. US GDP outlook = no bueno

Good morning and happy Monday - let's get smarter

EBIT-DUH?

Last week we talked about valuing companies based off of multiples that are applied to a financial metrics

Often that metric is EBITDA

So what is EBITDA and why does it matter?

In the finance world, you’ll constantly here EBITDA being thrown around

EBITDA, or Earnings Before Interest Taxes Depreciation and Amortization is a proxy for a company’s core recurring business cash flows before capital structure (debt or equity) and taxes

Before capital structure simply means the company could be capitalized (or funded) with debt or equity, and that’s not part of the core business operations of selling widgets or services

For example: You could be capitalized with 90% debt and 10% equity so your interest expense is off the charts. This expense does not have to do with your widget making or selling, it has to do with how your capitalized / funded aka not part of core operations

Additionally, if someone were to come in and buy the company, the %’s of debt and equity (capital structure) would change, so when they are looking at the numbers any metrics including interest would be irrelevant to them

EBIT is a proxy for a company’s core business profit, as opposed to cash flows

So wait.. Why is EBIT a proxy for profit and EBITDA a proxy for cash flows?

Because EBIT includes non-cash expenses (EBITDA does not), like Depreciation and Amortization that are core to the business, but are non-cash expenses

By non-cash I mean if that when the business records depreciation on a building they own, they don’t actually pay anything to anyone in cash

When that company records an expense for their internet, they will actually be paying that out in cash now or later <- that’s the difference

EBITDA adds back depreciation and amortization since they are non-cash, to get you back to your core business cash flows as opposed to profits

Net income (Net Earnings above), is your profit after all taxes and all expenses

Adjusted EBITDA - wait what?

So when you are looking to sell your company, not only are investors bidding off EBITDA which is > net income, but there are also adjustments (often called “add-backs” to EBITDA), making EBITDA even higher!

What are some typical add-backs or adjustments?

• One-time or non-recurring expenses (one time legal expenses, one time consultant fees)

• Start-up costs

• Owner’s compensation (if they aren’t necessary for the business)

• Personal expenses (car, golf membership)

• Proforma addbacks

  • Proforma adjustments are adjustments that you know about in the future of the business that you are accounting for today

    • For example: We know we will not be keeping our office space in 2023 so add that back to our EBITDA to show what our EBITDA is without that expense

• Discretionary expenses

  • Contributions to charity based on discretion that aren’t necessary for the business

A lot of sellers in M&A will try and addback things they cannot justify or have no supporting documents for

That is why there is often A WIDE gap between net income (actual profit), EBITDA (unadjusted), and adjusted EBITDA

Leading to memes that I have tweeted like this

US GDP Forecast

As talked about quite a few times, stocks (equities) typically perform a lot better when the macro environment is GDP accelerating QoQ (quarter over quarter), and stocks typically perform a lot worse when GDP is decelerating QoQ

As you can see below, GDP is decelerating into Q2 (bearish for risk assets like stocks)

Don't get fooled into bear market bounces and chase rips

There is a time for adding risk assets such as stocks and crypto, but that time is not now

Be patient, trust the data

- Dev

DISCLAIMER: None of this is financial advice. This newsletter is strictly educational and is not investment advice or a solicitation to buy or sell any assets or to make any financial decisions. Please be careful and do your own research.