Brad Feld

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Don’t Adjust My EBITDA

May 25, 2007
Category Term Sheet

In my first business, we didn’t have a line for EBITDA on our financial statement.  We went straight to Net Income.  We knew our cash flow from our statement of cash flows (and our bank account which we checked regularly since we were self funded.)  We never talked about EBITDA, nor did we ever feel the need to come up with things like “Adjusted EBITDA.” 

Now – I went to business school so I knew what an EBITDA was – I just didn’t care much about it at Feld Technologies because it didn’t matter.  Cash mattered the most.  Cash Flow mattered next.  Net Income mattered a distant third (as long as it was positive every month – it got more important if it was ever negative, but it was still third.)  The list continued.  EBITDA was not on it.  This was 1987 – 1993.

Earlier this week I looked at financials for a company I’m not involved in.  Cash has been vanishing at an uncomfortable rate so I was asked by a friend who is involved in the company to dig into the financials to try to understand what was going on.

The first financial presentation I saw focused only on adjusted EBITDA.  It was sort of defined, but not really very clearly (I didn’t know the dynamics of the elements of the adjustment well enough to have a good understanding at first glance.)  Cash flow was buried in one of the back pages of the financials (and not explained in the presentation.)  EBITDA wasn’t really visible; Net Income wasn’t really visible – it was all revenue and adjusted EBITDA.

Revenue was strong (it’s a good sized company – not huge – but nice growth.)  Adjusted EBITDA is positive.  Balance sheet cash is declining rapidly month over month.  Hmmm.  That doesn’t work.

I punted on the financial presentation (e.g. please don’t send me your explanation – just send me your cash flow statement, balance sheet, and income statement – by month for the last twelve months – as it comes out of your accounting system.)  Easy to do – I had it quickly.

EBITDA is very negative.  However, it’s still not as negative as the cash flow.  This is an equipment intensive business so about 50% of the delta was “adjustments associated with customer acquisition”, 25% of the delta was capital equipment (CapEx) investments, and 25% of the delta was “other things that got rationalized as adjustments to EBITDA.”

Not only was adjusted EBITDA pointless, it completely obfuscated what was going on.  However, the CFO of the company was spending all his time focusing his CEO and investors on adjusted EBITDA to explain how the business – while losing piles of cash – was really doing just fine on an operating basis “if you just didn’t count these couple of things.”

Last week the WSJ Journal has an article titled Profit as We Know It Could Be Lost With New Accounting StandardsThere is a potential massive overhaul in financial reporting coming (the accountants and the AICPA will need something to do in 2008 now that everyone is finally figuring out how to deal with SOX) – you can see some before and after examples here.  They are actually pretty interesting (as interesting as accounting gets – not up there with Lost or 24).  However, the first step is banishing all of the “adjusted stuff” in the financials.  Not helpful.