In other words, EBITDA gives you an indication of how much earnings before interest, taxes, depreciation and amortization the company makes with all the invested capital. Negative number is a red alarm for a company, meaning that the company is facing fundamental problems with its operations.

Normally practitioners consider normalized EBITDA only (management adjustments, pro-forma adjustments and other adjustments), since one off events may sometimes represent a significant role.

Due to fast and easy use of EBITDA, the metric is dominating the financial world. Its applicability makes it a #No.1 indicator. Furthermore, it is often used in relation with debt, value and performance indicators:

– Leverage: Financial obligation/EBITDA

This metric measures how does the debt relate to the ability of generating the operational profit. It can be argued that a leverage > 4 is not acceptable for banks anymore.

– Interest coverage: EBITDA / Interest expenses

This metric measures the ability of a company to cover its interest out of its operations. It is obvious that a ratio <1 is not sustainable.

– Value multiplier: Enterprise value/EBITDA (EV/EBITDA)

This metric measures how the market values the firm according to its ability to generate operational profits.

– Performance indicator: EBITDA / Total revenues (EBITDA margin)

This metric is a relative indicator and offers a great way to compare the company performance with its competitors.

EBITDA is further developed into EBITDAR and EBITDARM in cases where costs such as rents, restructuring fees and management fees represent a significant amount. These is especially typical for retail industry, REITs, hospitals, etc.

Nowadays more and more financial practitioners are aware of the underlying interpretational problems of EBITDA. The metric that overcomes the disadvantages of EBITDA is the economic value added model (so called EVA model). Even though the model as such is more advance, it relays on subjective assumptions related to the cost of capital calculation.

Are you interested in boosting your EBITDA? Check our performance improvement services or contact us directly!

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The owners of a privately-held engineering company engaging in medium-size utility projects approached us in panic to organize the sales process and find a solution to provide the sufficient liquidity until the new owner steps in. The company was performing extremely poor recently and felt into serious liquidity problems. Revenues collapsed and levels of financial debt rose in three quarters of a year from sound indeptedness to 180% D/E and 10,3x Debt/EBITDA. Owners were 100% sure that the company is on the way to bankruptcy and were only expecting a small fee for it.

According to their opinion, potential buyers could be managers, currently leading the company.

Addressing the pain: Company worth in the context of value generation

Consilue approached the valuation in line with the top-down approach, which also included in-depth analysis of the industry. After careful examination, we figured out that the demand for projects is highly correlated with cofinancing activity of EU structural funds and the valuation date matched the transition between the two investment cycles. Furthermore, the size of the EU contribution for the next investment cycle was also significantly changed for the key markets the client used to serve in the past.

After understanding the reasons which pushed the client into liquidity issues, we performed the in-depth financial analysis. We broke-down business into individual projects and analyze and project the developments one by one. We figured out that the company is in fact expecting a good profitability in the following two years, they only need to re-focus their activity on more prosperous countries in the region. Furthermore, also a significant increase in the cash conversion cycle (mainly increase in accruals) already indicates better times and is in fact by its nature only temporary.

For decision-making purposes, we decided to simulate the generation of economic value by years with and without operational restructuring and improvement in profitability. The purpose was to show the shareholders the importance of the active involvement into the future business activities of the company.

Later on we performed also the corporate valuation based on going concern. Since we used market value as our base value, also successful operational restructuring was assumed.

Results: Company worth estimate done right

We have showed the shareholders that the market value on the date of valuation is in fact significantly above their expectations. They understood that they were played by managers to sell them the company for the cheapest possible price.

Despite the existing high levels of debts, we persuaded banks to support the company with the short-term liquidity injection and stand aside.

Client’s testimonial:

When estimating the value of the company we took the EBITDA and multiply it with a given multiple. That was so wrong and almost costed us millions. One truly needs to understand where the value comes from. In our case, it was generated from the change in net working capital (decreasing the accruals) in the first year and strong EBITDA in the first two years.

We are sincerely thankful to Consilue for showing us the right path. Now we are about to change the management and actively approach the operational restructuring.

Advisor’s thought:

Valuing a company requires a deep understanding of the business. Often the process reflects many interests and fast response – as in given case – which makes it challenging.

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