By Tad N. Render, CPA, Principal
The COVID-19 virus has had a profound effect on the world economy. One important consideration of the pandemic is its impact on a company’s enterprise value. As a result of the coronavirus pandemic, a new financial metric for measuring profitability has been created – EBITDAC (Earnings Before Interest, Taxes, Depreciation, Amortization, and Coronavirus).
What started as a joke coined on a mug, is quickly becoming an actual financial metric in the merger and acquisition industry. It is widely reported that Schenk Process Holding GmbH, a German manufacturer, was the first company to use the term “Adjusted EBTIDAC” to increase its profitably 40% in its first quarter 2020 filings. Here in Chicago, The Azek Company, used EBITDAC to add back “lost earnings” in its financial materials used to raise $325 million of corporate debt.
What Is EBITDA?
EBITDA is an acronym that stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization.” Many businesses use EBITDA as a measure of operating profitability and often as a proxy for cash flow. Accordingly, the financial metric is frequently used as a starting point to value middle-market businesses. More specifically, one would apply a multiple to a company’s EBITDA to help determine enterprise value.
What Is Adjusted EBITDA?
A company’s EBITDA calculated from its historical financial statements may not paint the entire picture. Oftentimes a business will have non-recurring items of revenue/expense or other revenues/expenses that would need to be normalized in order to present more realistic profitability. Examples of common EBITDA adjustments include:
- One-time legal settlements
- Non-recurring special project revenue
- Non-business entertainment expenses
- Above/below market executive compensation or benefits
- Above/below market rent expense
The Introduction of ‘C’ to EBITDA?
As the coronavirus pandemic spread, the profitability of many organizations was directly or indirectly impacted. Many businesses were forced to close under government mandated shelter-in-place orders. Other entities found it difficult to source material and in turn were unable to fulfill customer orders. Further companies were unable to pivot to a remote workforce and suffered a decline in revenues.
The addition of the ‘C’ to the traditional EBITDA metric is meant to quantify a company’s losses attributed to the coronavirus pandemic. Examples of potential “coronavirus” adjustments include:
- Lost revenues and profits
- Disruptions to workforce (including employee severance or “combat pay” bonuses
- Lease termination costs
- Disruptions to supply chain (cost increases, expedited freight, etc.)
- Declines in efficiency due to remote work environment
While the profitability of most companies has been negatively impacted from the effects of COVID-19, certain industries performed better during the pandemic. When evaluating the quality of a company’s earnings, care should be taken to evaluate both the positive and negative impacts of the pandemic.
Proceed with Caution
Many entities will try to add back lost revenues and profits due to Covid-19 to its Adjusted EBITDA. However, no one knows what the true earnings of a company would have been had the pandemic not occurred. Sellers may blame the coronavirus to disguise other problems or issues which are occurring in the business. The “lost revenues” need to be examined carefully to determine if they are purely due to the coronavirus and not for another reason such as lost to competitors or other reasons. Furthermore, a company may incur expenses to continue to comply with health requirements or a remote workforce. When evaluating Adjusted EBTIDAC, it is critical for all parties to obtain support for proposed coronavirus adjustments. Just like when going out in public these days…proceed with caution.
Tad N. Render, CPA leads the Transaction Advisory Services practice at Miller, Cooper & Co., Ltd., a Chicago-based accounting and consulting firm. The Transaction Advisory Services group specializes in buy-side and sell-side financial and tax due diligence and related quality of earnings work for lower middle-market businesses.