Obtain EBITDA and Free Cash Flow in Credit Agreements


When WeWork prepared for a bond issue in 2018, underwriters raised concerns about its leverage. The company’s response was not to reduce leverage by adding equity or reducing debt, but by adjusting EBITDA until it got the ratio it wanted.

“We all know how this story ended,” Andrew Holmes, director of Moody’s Analytics, said in a Moody’s Analytics webcast last week.

By turning his loss of $ 193 million in earnings before interest, taxes, depreciation, and amortization (EBITDA) in 2017 into positive EBITDA of $ 233 million, he wiped out his financial leverage problem without having to make any changes to his expected obligation. offer.

“People didn’t believe in community adjusted EBITDA,” he said, but that didn’t stop them from investing in the business.

This is a case in which the company adjusted EBITDA to meet its short-term needs while masking a long-term leverage issue that peaked in 2019, when it had to withdraw its IPO due to valuation issues.

Extreme case

Holmes called the WeWork saga a warning about the misuse of EBITDA, a metric that can provide a good measure of business performance over time and is useful for building valuations, but is too much. often seen as an indicator of cash flow or, in some cases, profitability. .

It is neither, which is why EBITDA often increases while cash and earnings decline, and vice versa, depending on market conditions.

But because so many people use it, it’s important that accounting professionals calculate it thoughtfully and consistently. “You want to be clear what this is about,” Holmes said.

Non-GAAP measure

It is unlikely that accounting organizations will treat EBITDA and its adjustments in a standardized way anytime soon.

This is because the measure, created by investment bankers to show promise of growth, is not recognized by generally accepted accounting standards (GAAP) in the United States or by international financial reporting standards ( IFRS) elsewhere.

Given the lack of standardization, organizations should perform their own calculation of EBITDA if they are trying to raise credit capital and the lender examines the measure in the leverage calculation.

“If you think someone is going to calculate your EBITDA, you should do your own,” and come up with that number, he said.

In WeWork’s case, it changed a negative to a positive by first calculating Adjusted EBITDA by making relatively common adjustments, including depreciation and amortization. WeWork then calculated what it called Adjusted EBITDA before growth investments by adding costs that are typically excluded, such as those for sales and marketing and new market development.

She justified the adjustments on the grounds that once the new office buildings were put into service, they would generate income without the company having to pay these expenses again.

“So add them up,” Holmes said.

It then made a subsequent adjustment – its Community Adjusted EBITDA – by adding general and administrative costs (G&A). It was “a new animal, never seen before in nature,” he said.

Cash differences

Another highly variable measure that lacks standardization is Free Cash Flow (FCF), but like EBITDA, lenders commonly use it to take out loans. For this reason, if you are looking to get credit principal from a lender that calculates payments based on it, you need to do your own math so that you know what you are up against.

“Look at this and not the EBITDA,” he said.

In general, FCF is the cash available to serve lenders and shareholders and to do things like acquisitions after the company has incurred expenses that are effectively mandatory.

You can think of it as adjusted EBITDA, but without interest, without changes in working capital, capital expenses and other line items, he said.

Some organizations also exclude dividends, which Moody’s recommends.

This is because companies generally treat dividends, albeit discretionary, as mandatory.

“Kellogg’s has paid a steady and growing dividend for decades,” he said. “If Kellogg’s CEO cut the dividend, would that impact his job prospects? You bet it would. Has he borrowed money in the past to pay his dividends? Yes he has. “

Private companies also consider dividends as compulsory, said Holmes.


While EBITDA and FCF measure very different things and can move in opposite directions depending on how companies respond to changing market conditions, accounting teams should be prepared to do their own calculations when trying to raise funds. credit capital.

“If you expect it to be paid off by cash flow, know how it’s calculated,” he said. “Know how cash flow varies from industry to industry and throughout the cycle. ”

Ultimately, EBITDA and FCF, despite their lack of normalization, are useful metrics, he said, but be careful when using them.


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