EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a measure of a company’s operating performance.
Adjusted EBITDA is calculated by taking Reported EBITDA and adjusting for any one-off or exceptional items. These adjustments are intended to strip out any one-off/exceptional items which are unrepresentative of the business going forwards. In other words, Adjusted EBITDA is used to illustrate the true underlying profitability of the business.
Here are some common adjustments to EBITDA along with actual company examples
1️) Provisions
Provisions are typically made for anticipated expenses, such as future tax obligations, asset retirement obligations, asset impairment, losses, pensions, and severance costs. Some argue that these provisions are not actual obligations and should be added back to EBITDA, while others believe they represent real anticipated expenses and should be included.
BP: In 2010, BP had to pay $20 billion for the 2010 Deepwater Horizon oil spill. The company made a provision for this amount, which was later added back to EBITDA during negotiations with potential buyers of BP assets.
GE: In 2017, GE made a $6.2 billion provision for long-term care insurance claims, which was excluded from its adjusted EBITDA.
2️) Non-operating income
Non-operating income refers to passive income that is not related to the company's core operations. Most parties agree that if the company is not actively generating that income, it should not be part of the company's EBITDA.
In its 2021 annual report, Apple Inc. reported net sales of $274.5 billion and operating expenses of $66.3 billion, resulting in operating income of $208.2 billion. However, the company also reported $3.7 billion in non-operating income, such as interest income and gains on investments.
To adjust for the impact of non-operating income on EBITDA, we would add back the $3.7 billion to the operating income figure. This would result in an adjusted EBITDA of $211.9 billion, which better reflects the company's operating performance.
3️) Unrealized gains or losses
Unrealized gains or losses are increases or decreases in the value of an asset or liability that has not yet been sold or settled. The typical view is that paper gains and losses do not belong in EBITDA, but others argue that declines in asset values are extremely relevant for current and future profitability and should be included.
In 2018, Facebook reported an unrealized gain on its investment in Chinese company Meituan-Dianping. Facebook's investment in Meituan-Dianping was made through its investment vehicle, Facebook Holdings LLC, and was recorded as a marketable security on Facebook's balance sheet. The value of Facebook's investment in Meituan-Dianping increased from $1.6 billion to $2.4 billion during 2018, resulting in an unrealized gain of $800 million.
When calculating EBITDA for the year, Facebook made an adjustment for the unrealized gain on its investment in Meituan-Dianping. This adjustment involved adding the unrealized gain of $800 million back to net income to arrive at adjusted EBITDA. Facebook noted that this adjustment was made to better reflect the company's operating performance, as the unrealized gain on its investment in Meituan-Dianping was not related to its core business operations.
4️) One-time revenue or expenses
One-time revenue or expenses are the result of non-recurring transactions. The typical view is that because they are not repeatable, they do not belong in EBITDA. However, others may seek evidence to prove the contrary and support that what appears to be a one-time event will actually repeat in the next period.
In 2019, Tesla, Inc. reported adjusted EBITDA of $4.1 billion, which was an increase of 2% compared to the previous year. However, the company also reported that it had incurred $117 million in restructuring charges during the year related to layoffs and plant shutdowns.
Tesla added back this one-time expense to its EBITDA calculation, resulting in an adjusted EBITDA of $4.2 billion.
5) Foreign exchange gains or losses
Foreign exchange gains or losses are the result of incidental transactions outside the company's core operations. If the company is not an FX boutique or exchange, FX gains and losses typically are not part of the company's EBITDA. This becomes a contentious topic when FX gains are claimed to be the result of purposely crafted and implemented FX hedging strategies.
In 2020, Apple Inc. reported EBITDA of $110 billion, which was a significant increase over the previous year. However, the company also reported that it had incurred a foreign exchange loss of $1.3 billion during the year due to fluctuations in currency exchange rates.
Apple added back the foreign exchange loss to its EBITDA calculation, resulting in an adjusted EBITDA of $111.3 billion.
6) Goodwill impairment
Goodwill impairment refers to a decrease in the value of goodwill reported following an acquisition. While this indicates concerns regarding the original price paid in the acquisition, it is still typically considered a "paper loss" that does not belong in EBITDA.
In its 2020 fiscal year, General Electric (GE) reported EBITDA of $17.3 billion, which was down from $22.4 billion in the previous year. However, the company also reported a goodwill impairment charge of $4.4 billion during the year, primarily due to the impact of the COVID-19 pandemic on its aviation business.
GE added back the goodwill impairment charge to its EBITDA calculation, resulting in an adjusted EBITDA of $21.7 billion.
7) Asset write-downs
Asset write-downs are decreases in the value of an asset, usually following non-recurring events such as sharp technological advancements that rendered a machine obsolete ahead of its time. The usual consensus is that because they are non-cash, they do not belong in EBITDA.
In its 2020 fiscal year, ExxonMobil Corporation reported EBITDA of $33.4 billion, which was a significant decline compared to the previous year. However, the company also reported asset write-downs of $19.3 billion during the year, primarily due to the decline in oil prices and the impact of the COVID-19 pandemic on demand for its products.
ExxonMobil added back the asset write-downs to its EBITDA calculation, resulting in an adjusted EBITDA of $52.7 billion.
8) Litigation or insurance expenses outside the regular course of business
Litigation or insurance expenses are the result of non-recurring transactions such as one-time lawsuits, large financing deals, or outlier commercial contracts. Some argue that if they are not repeatable, they do not belong in EBITDA.
In its 2020 fiscal year, Johnson & Johnson (J&J) reported EBITDA of $27.5 billion, which was up from $25.6 billion in the previous year. However, the company also incurred significant legal expenses related to ongoing litigation over its talc-based baby powder product, as well as insurance expenses related to product liability claims.
J&J added back the litigation and insurance expenses to its EBITDA calculation, resulting in an adjusted EBITDA of $32.1 billion.
9️) Owner compensation over/under market value
In private companies, owners often do not pay themselves a fair salary, or they pay themselves more than a comparable executive role would pay an employee. A buyer will usually adjust the owner's salary to level up to the market and will impact EBITDA upwards or downwards in the process.
In its 2020 fiscal year, Tesla reported EBITDA of $5.4 billion, which was up significantly from the previous year. However, the company also paid its CEO, Elon Musk, a compensation package worth over $11 billion in stock options. This compensation was well above market value and was a controversial topic among investors.
Tesla added back the excess CEO compensation to its EBITDA calculation, resulting in an adjusted EBITDA of $16.4 billion.
10) Share-based compensation
Share-based compensation refers to stock options or other equity awards given to employees as part of their compensation package. Some argue that these are not actual cash outflows, while others maintain that they are real expenses incurred to attract and retain executive-level talent.
In its 2020 fiscal year, Facebook reported EBITDA of $35.2 billion, which was up significantly from the previous year. However, the company also granted significant amounts of share-based compensation to its employees, particularly in the form of stock options.
To provide a clearer picture of its underlying operating performance, Facebook added back the cost of share-based compensation to its EBITDA calculation, resulting in an adjusted EBITDA of $51.5 billion.
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