Business Buyers Will Always Check For This… It Could Be Costly
Blog Series 5 of 6
Author: Mark Mroczkowski
The business world often refers to earnings before interest, taxes, depreciation, and amortization, more commonly known as “EBITDA.” Public companies, private companies, business owners, investment bankers, lenders, valuation firms, and the mainstream business media constantly reference EBITDA and use it as a business term to negotiate value, define agreements, and reference cash flow. However, EBITDA is not cash flow and may or may not approximate cash flow. EBITDA is not a measurement recognized under Generally Accepted Accounting Principles (GAAP). The term EBITDA was created in the 1970s to demonstrate the cable television industry’s cash flow generation potential and was also used by leveraged buyout firms. Over time, this non-GAAP metric has taken center stage and is widely used to demonstrate a company’s financial health. Unfortunately, this metric ignores certain cash expenditures that must be paid, such as capital expenditures, debt service, taxes, and changing working capital requirements. These cash outlays must be understood and adequately reflected in any cash flow analysis and company valuation.
Buyers care that a business under their ownership can: (i) reinvest in and expand its capital assets (capital expenditures), (ii) service its debt, (iii) give raises and bonuses to its employees, and (iv) deliver equity returns to its shareholders.