EBITDA

EBITDA what it is, where to find it in your accounts and why it matters..

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Earnings Before Interest Tax Depreciation & Amortisation

There’s a video below below showing you how & where to find it in a set of accounts… but first I’d like to explain why EBITDA is so important…

The finance community use it to compare your performance over time and with others…

… that’s it…

And to do that they need as clean a sense of your profits (earnings) as they can get…

So… they want a profit figure Before :

Interest

Because Interest is a function of capital structure… (some companies have debt, some don’t)… to compare performance between companies we want a profit figure that ignores a company’s capital structure…

Tax

Tax regimes around the world (and even across industrial sectors) can be / are different… so to compare performance between companies we want a profit figure that ignores Tax

OPERATING PROFIT

Ignoring Interest & Tax gives us your EBIT (Earnings Before Interest & Tax)… in a UK set of accounts you’ll find EBIT as Operating Profit in the Profit and Loss

Depreciation

Finding EBIT is easy… but now we have to dig around the accounts to find the ‘Depreciation charge for the year’ and add that back to the Operating Profit…

Why ? Because Depreciation is a book-keeping entry based on a policy decided by the company’s directors… one company might depreciate its assets (say vans) at 25% pa… another at 33%… which can affect profit dramatically

To compare performance between companies we want to ignore such a moveable / arbitrary / manipulable number

Amortisation

Fancy, old fashioned word for Depreciation of an Intangible Asset (such as Goodwill)… and as with Depreciation it needs to be added back if we want to compare company performance

EBITDA… There you have it

A universally used metric to measure performance… that you can’t find…

… you have to work it out… by :

  1. finding Operating Profit (from your P&L)
  2. adding back Depreciation & Amortisation (which you’ll find in the notes to your accounts… it’s the ‘charge for the year’ in the Fixed Asset (Non-Current Asset) table

 

 

 

 

DSCR what it is and why it matters

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DSCR is the Debt Service Cover Ratio required by bankers… typically when they are ‘cash’ lending for an MBO, acquisition etc

They want to make sure a company’s annual Cash Flow can cover its annual Debt repayments… and they add a little bit on for comfort

So… let’s play numbers

If a company has £100k Debt repayments (including interest)

And their Bankers apply a DSCR of 1.3

Then the company must have CFADS (Cash Flow Available for Debt Service) of £130k to keep their Bankers happy

In the Real World

The calculation is done the other way round… so

Say our company has CFADS of £500k

And their Banker’s DSCR of 1.25

Then the company has a Debt repayment capacity of £400k

The Bank will then deduct any existing Debt repayments (Funding Circle loan, HP payments) … say e.g. of £100k

The Bank now thinks the company can cope with an extra £300k of Debt repayment each year…

For an MBO they may typically lend over 3 to 4 years… meaning our company can borrow an extra £900k to £1.2m

CFADS

Obviously DSCR is just about symbiotically linked to CFADS… so check out the post and video on CFADS here

 

CFADS how to calculate it and why it matters… and it does

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CFADS is a measure of a company’s Cash Flow Available for Debt Servicing… and it matters because Bankers like it… so if you’re looking at an MBO or going on an acquisition spree chances are your bankers will look at your CFADS to see if they want to come along…

Calculating your CFADS… and how much they’ll lend you

Here’s a video working through the nuts and bolts of calculating your CFADS & what a bank’ll lend… and if you want a spreadsheet to help you out drop me a line at pete@pete-wild.co.uk

Essentially Banks :

1.Caluclate your CFADS

2.Adjust for their required DSCR (Debts Service Cover Ratio)

3.Deduct any existing Debt repayments you’re making

4.Multiply the result by 3 or 4

And that tells them what they can afford to lend based on the company’s ability to generate enough cash to pay them back

In the Real World

What if your CFADS won’t get you the cash you need?

All may not be lost if your CFADS doesn’t quite support the money you’re looking to borrow…

… in the real world the banks are often trying to work to a figure you need them to hit because that’s the number you’ve agreed for the MBO or acquisition…

… so your Banker may well work with you to help get the CFADS figure to where it needs to be (see the video above) … hey… your Banker has a target to hit, bonus to earn, and he knows that if he says no you’ll be off somewhere else…

… and bankers hate losing clients

MBO … you know it makes sense

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I’m seeing an increasing appetite among bankers to fund an MBO… which is a great thing all round.

Owners get to sell all or part of their holdings and realise value… to people who know the company well and are seriously committed to making sure it survives and thrives

Bankers get to fund a team who know the company warts & all, yet still want to financially hitch themselves to the company wagon for years to come… And if the Bankers funding the deal are the company’s long-time bankers, with a real knowledge of the company and its prospects, so much the better

And there’s more… much more

Not only do seller and funder get what they want (value extracted … chunky low-risk funding)… they get it quick… and I mean quick

High Street bankers can and really do turn an MBO around in less than 2 months.

Think about that.

8 weeks from today you could have sold out… if you’ve a team who’ll buy

Compare that to the market…

I typically tell owners to expect to wait a year for their money if trying to sell in the market… and not to expect any deal to go through… because few do…

A willingness to get the deal done, quickly, by all involved, with minimal-to-no Due Diligence helps cut the time… as does the comfort the bankers get from funding a team who know the business better than any Due Dil team could

CFADS

For the Bankers an MBO is a form of cash lending… they look less for security and more for an ability to repay… and to measure that ability a lot of them lean heavily on the company’s CFADS

I’ve a separate post on CFADS for the seriously interested… but for the passingly-curious it stands for Cash Flow Available for Debt Servicing

Once the Bank have calculated a company’s CFADS they knock off any existing debt repayments the company has… add a margin of cover … and will typically lend up to 3 or 4 times the remaining figure

In the The Real World

Your Company Valuation is irrelevant…

Again… think about that… the Bank works out its willingness and ability to lend you an AMOUNT… no mention of value here...

… so that amount could be for all your shares… or just 70% of them… leaving you with 30% as your team take on the business…

… in fact your Bank would prefer it if you don’t sell out entirely… no whiff of ‘cutting & running’… plus the old owner is still around to help the new owners…

So what’s the catch?

You still need all the deal-making & legals doing right

Heads-of-Terms… an SPA (Share Purchase Agreement)… a Shareholders Agreement… as well as any Service Agreements (e.g. for your new role, and for their new roles)

And the bank will want all the forecasts they can eat…

But none of that stuff should stop the deal happening within 8 weeks from now

Wow

But what about the M in the MBO ?

For Management this will be a big step up… and in the old days it meant lots of  PGs (Personal Guarantees) and some skin in the game (in the form of perhaps one year’s salary)

But the old days are gone… we are in a world awash with cash… and the banks aren’t pushing for skin… and any PGs can be limited to silly low numbers (which the selling owner can guarantee if that helps get the deal done)

Interesting times… 

I’m absolutely convinced there are no meaningful supply side issues when it comes to companies like yours getting funding… it’s the demand that’s lacking…

… and I’m also absolutely convinced the banks keenness for these MBO deals is strongly correlated with this supply / demand mismatch…

… long may it continue…