So what is EBITDAC? Top tutor Tom Clendon explains all.
I have recently seen reports that some companies are considering reporting their 2020 profits before the effect of Covid-19.
The suggestion is that it would be beneficial to adapt Earnings Before Interest Tax Depreciation and Amortisation (EBITDA) so that it became Earnings Before Interest Tax Depreciation Amortisation and Covid-19 (EBITDAC). But what exactly is EBITDA, what adjustments could be made to this to make it EBITDAC and would users benefit anyway? This article will explore these questions.
Alternative Performance Measures
In our highly regulated world, financial statements of UK quoted companies must be drawn up and published in accordance with IFRS GAAP. Thus, the format of the income statement is prescribed and standardised. This is aimed at giving users confidence in the numbers that are reported. A regulated and standardised approach is designed to enhance comparability.
However, in addition many companies also voluntarily produce alternative performance measures (APMs). In other words, in addition to the various measures of performance outlined in] the income statement (e.g. operating profit and profit after tax) other measures are published.
This is a tacit acknowledgement that the information required by regulators do not wholly satisfactorily meet the information needs of a company’s users.
After all, it should be acknowledged that one size does not fit all. APMs at their best seek to provide bespoke information about the company’s performance that will help the user better understand the performance of the company and even predict its future performance.
This is probably the most famous of all APMs. Many companies even publish their own EBITDA even though it is not required, and not defined by any IFRS. So, let us explore why it can be argued that EBITDA is a useful measure of performance.
• Before interest. This is because companies are financed by different mixtures of debt and equity. Equity does not give rise to an interest expense, but debt does. Thus, by taking a performance measure before interest it enhances the comparability of the underlying performance of companies that have different financial structures.
• Before tax. This is because companies operate in different tax jurisdictions and suffer different tax rates accordingly. Thus, by taking a performance measure before tax this enhances the comparability between companies. Also, there is an argument that the tax expense is not under the control of management and so on that basis there is more management accountability and stewardship on pre-tax earnings.
• Before Depreciation and Amortisation. This is partly because these are subjective non-cash expenses. However, another reason for taking a performance measure before depreciation and amortisation (and impairment losses) is because some companies grow by acquisition (takeovers) whilst others grow organically.
The companies that grow by taking over other businesses will have more of these expenses. This is because acquisitions result in upward fair value adjustments on assets and thus subsequently more depreciation. In addition, the goodwill that arises on acquisition will eventually pass through the income statement in the form of impairment losses. Companies that grow organically will not have these additional expenses. Thus, by taking a performance measure before depreciation and amortisation (and impairment) it enhances the comparability of the underlying performance of companies that have historically pursued different growth strategies.
• Before Exceptional items. While not in the acronym, when coming up with an alternative measure of performance companies often look to exclude unusual and non-recurring income and expenses. These are considered irrelevant when considering the expected impact on future performance. Excluding these one off items arguably enables users to understand the underlying performance. This makes the APM predictive and therefore more relevant to users.
So let us consider EBITDAC. After all, the impact of the Covid-19 has been pervasive, but it has impacted businesses in different ways. Let us try to understand what adjustments may be made to arrive at EBITDAC.
Because of the Covid-19 most business will have incurred additional costs. Impairment losses, provisions for redundancies and additional cleaning costs to name but three. These could be added back to EBITDA on the basis that they were non-recurring. However, given the likely duration of the Covid-19 impact this could be hard to argue.
Some might advocate that EBITDAC should also reflect additional hypothetical revenues and profits that would have been earned if the Covid19 had not occurred. I am very uncomfortable with this suggestion. The measurement of profit is part of stewardship and so should reflect what has happened. History should not be rewritten in this way. It could not be a faithful representation.
While there is some merit in the measure of EBITDA, it seems a step too far for me to convert it into EBTIDAC. Users will be better served by management setting out a clear narrative explanation as to the future of the business in these uncertain times.
• Tom Clendon is the SBR online lecturer with FME. See www.tomclendon.co.uk. He can be reached on via WhatsApp on 07725 350793