What is Cash Adjusted EBITDA
The cornerstone of finance is understanding and interpreting financial data and financial metrics. They provide a comprehensive view of a company’s operational performance and overall financial health, acting as a diagnostic tool for investors, analysts, and business owners to cut through the noise. Cash Adjusted EBITDA is an essential financial accounting metric often used and deserves particular attention.
First, we must define EBITDA – Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA is an oft-used metric that financial analysts and investment bankers use; however, EBITDA has shortcomings. There has been an evolution of the financial metric to provide more detail and better accuracy. More comprehensive metrics such as the Adjusted EBITDA and Cash Adjusted EBITDA are now more commonplace than they have been.
Cash flow is the lifeblood of any business, so considering cash adjustments is of particular use in analyzing a company’s financial position. Cash Adjusted EBITDA, in particular, provides a more realistic perspective on a company’s earning capacity, as it incorporates cash inflow and outflow adjustments to the original EBITDA metric.
The following article will delve deeper into Cash Adjusted EBITDA and why it is so relevant in today’s financial landscape.
Understanding EBITDA
EBITDA is a widely used financial metric used to assess a company’s operational profitability. Understanding it fully requires looking at its components, particularly interest, taxes, depreciation, and amortization.
Interest is the cost of borrowed funds, while taxes represent the amount paid to governments from a company’s profits. Depreciation is the reduction in value of tangible assets, such as machinery and buildings, over time due to wear and tear. And finally, amortization is the gradual reduction of an intangible asset’s value – things like patents or copyrights that can’t be easily valued.
When calculating EBITDA, all of these components are simply added back to net income, effectively providing a measure of profitability from the core business operations. Essentially, it isolates earnings from the operational activities by excluding expenses that may deviate from the business’s true performance.
This metric is valuable and offers a simplified view of a company’s financial performance. It is especially useful when compared with competitors within the same industry, helping investors and analysts focus on earnings generated from core operations while ignoring the differing financial and accounting practices. And while EBITDA provides a useful snapshot of operational efficiency, it also comes with limitations – this is where Adjusted EBITDA and Cash Adjusted EBITDA come into play.
Adjusted EBITDA: A Closer Look
While EBITDA is a great starting point for understanding a company’s operational profitability, Adjusted EBITDA goes one step further. It includes adjustments for certain items that may distort the true earnings potential of a business, for better or worse. Adjusted EBITDA refines EBITDA by adjusting for things such as non-cash expenses, one-off items, and other irregularities in the financial statements to give a more clear, better comparable figure of operating performance.
Non-cash expenses, like stock-based compensation, are added back to the figure, as they are not actual cash outflows. Adjustments are also made for items like deferred revenue (money received but not yet earned), and unusual of one-off expenses or income not expected to recur in the future. Those types of revenue drivers or costs are not helpful and skew the understanding of the business profitability if not removed or added back.
Calculating adjusted EBITDA is similar to that of EBITDA, adding back interest, taxes, depreciation, and amortization, but those further adjustments are made after, resulting in the adjusted EBITDA figure. This will be a more useful metric for investors, analysts, and otherwise for making better decisions about a company’s financial health, especially when compared with similar industry competitors.
The Significance of Cash EBITDA
Moving along to another variant of EBITDA, next up is Cash EBITDA, which adds a crucial element to the metric: cash. While the prior two variations can provide valuable insights, they don’t necessarily reflect the cash flow generated by the business, which is critical to continuing business success and viability in the long run. Cash EBITDA closes that gap – it focuses on cash earnings, leading to a better representation of the company’s financial situation.
The cash-based transactions are what differentiates Cash EBITDA from its predecessors. To calculate, instead of simply adding back interest, taxes, depreciation, and amortization to net income, Cash EBITDA adjusts for the actual cash inflows and outflows associated with operations. That means cash from actual customer purchases, cash paid out to suppliers and employees, and other cash-related business activities. In other words, it looks at how much cash a business generates from its operations.
The process of adjusting for cash flow involves a little more work than the prior calculations, as it involves examining the company’s cash inflows and outflows and making adjustments to the EBITDA calculation accordingly. The examination of accounts receivables, accounts payable, inventory, and other line items from the cash flow statement will be needed to reflect the operational cash movement.
The emphasis on these actual cash movements makes Cash EBITDA an excellent tool in assessing a company’s liquidity, solvency, and overall finances. It’s all about understanding the company’s ability to generate cash – something needed to pay off debts, make new investments, and maintain daily operations.
Diving into Cash Adjusted EBITDA
Cash Adjusted EBITDA goes beyond the standard adjustments and offers a deeper and more nuanced view of a company’s profitability. It combines the principles of Cash EBITDA and Adjusted EBITDA by considering non-recurring, one-off items that could potentially distort a company’s profitability assessment. It then adjusts these items on a cash basis to add another layer of refinement, reflecting the actual cash inflows and outflows tied to operations.
This measure provides a more accurate understanding to a company’s liquidity and cash-generating capability, and also revelas a company’s financial strength by highlighting its capacity to generate cash. The capacity to generate cash is vital for businesses, and is a metric for meeting financial obligations, making investments, or surviving potential economic downturns.
To calculate Cash Adjusted EBITDA, start with EBITDA, add or subtract the necessary cash adjustments, and then further adjust for any one-time, non-operating, or non-cash items. These can include changes in working capital, non-cash expenses, one-off gains or losses, or other such items.
For example, suppose a company reports a net income of $1 million, interest expense of $100,000, taxes of $200,000, depreciation of $50,000, and amortization of $50,000. Additionally, non-cash expenses of $25,000 occur and a one-time gain from the sale of assets amounted to $75,000 in the period.
The EBITDA for this company would be: $1M + $100k + $200k + $50k + $50k = $1.4M
The Cash Adjusted EBITDA would be $1.4M + $25k – $75k = $1.35 million.
This $1.35 million is a better understanding of the company’s true cash-generating capability from its operations.
Cash Adjusted EBITDA and Company’s Financial Health
Cash Adjusted EBITDA is pivotal in assessing a company’s financial health. It accurately measures the cash generated from a company’s core business operations, making it indispensable for investors, financial analysts, management, and other stakeholders to use in assessment.
This is important because Cash Adjusted EBITDA emphasizes cash – and a business’s need for cash cannot be understated. By considering the cash inflows and outflows, the metric gives a realistic picture of a company’s liquidity and ability to meet financial obligations. It helps identify companies that might be profitable on paper but are struggling with cash flows, which can lead to insolvencies if not managed properly.
Comparing Cash Adjusted EBITDA to net income can also offer some insights. While net income includes all revenues and expenses, Cash Adjusted EBITDA isolates cash generated from the core operations. It strips out the influence of those non-cash items and one-off events, making it a more reliable indicator of operational performance.
One metric that can be utilized is the Cash Adjusted EBITDA margin, calculated by dividing Cash Adjusted EBITDA by total revenue, providing a percentage to measure a company’s profitability. This margin can then be compared to industry peers, with a higher margin indicating a more efficient company in converting sales into actual cash profit. Thus, Cash Adjusted EBITDA can provide an in-depth view of a company’s financial health by emphasizing cash generation from the core operations.
Cash Adjusted EBITDA vs. Other Financial Metrics
While each serves its unique purpose within the vast universe of financial metrics, providing insights into various facets of a company’s financial state, Cash Adjusted EBITDA can be compared with some other commonly used metrics such as Gross Profit Margin, Return on Investment (ROI), and Net Profit Margin.
Gross Profit Margin measures a company’s profitability after considering the Cost of Goods Sold (COGS), reflecting production efficiency and pricing. However, that doesn’t consider operational expenses, interest, taxes, or cash-based adjustments, which are integral parts of the Cash Adjusted EBITDA.
Return on Investment (ROI) is a performance measure used to evaluate an investment or compare the efficiency of two or more different investments. While ROI considers the profit against the cost, Cash Adjusted EBITDA assesses the cash generated from those operations, offering a more granular view of operational efficiency.
Net Profit Margin is a measure of the profitability of a business after all costs have been deducted from revenue. Although it is similar to assessing profitability as Cash Adjusted EBITDA, Net Profit Margin does not focus on operational cash flows or make cash-based adjustments.
The cash basis of EBITDA and its difference from other financial metrics is what makes it unique and valuable. Assessing a company’s liquidity, solvency, and overall operational efficiency is a tall order, but doing so without considering cash will give you false security with the final assessment, which could lead to problems down the road.
Practical Use Cases of Cash Adjusted EBITDA
Within the business world, the value of Cash Adjusted EBITDA can provide many practical uses.
Firstly, Cash Adjusted EBITDA is key to determining a company’s fair market value. When valuing a business, potential investors or buyers often look at the Cash Adjusted EBITDA as a measure of the company’s ability to generate cash from its operations, free from financial structure, taxation, and non-cash expenses, which provides a truer picture of cash profitability. This will provide more a more accurate end valuation.
Secondly, investment bankers and financial analysts widely use Cash Adjusted EBITDA to emphasize actual cash flows, which makes it robust for assessing liquidity, financial stability, and investment potential. This data is extremely helpful in comparing companies across industries by eliminating the effects of varying capital structures, tax rates, and non-cash accounting practices. It’s also useful in M&A due diligence and LBO modeling, where cash flow analysis is critical.
Finally, it can be used to derive normalized EBITDA, another variant for company valuation. Normalized EBITDA adjusts for non-recurring, non-cash, or one-off items to represent a sustainable level of earnings a company can generate. When these adjustments happen on a cash basis, as in Cash Adjusted EBITDA, it can lead to more precise assessments of the company’s ongoing earnings potential, enhancing valuation accuracy.
Conclusion
In this exploration of Cash Adjusted EBITDA, we have uncovered the inherent value of the financial metric in evaluating a company’s financial health – one that is far superior to simply looking at earnings or EBITDA alone. Its importance lies in its ability to precisely depict a company’s cash-generating capability from its operations, incorporating adjustments based on actual cash inflows and outflows. This offers a more accurate, clear-cut view of operational profitability and efficiency.
While Cash Adjusted EBITDA has some advantages, it is but one of the many tools in the vast financial metric world. One metric alone cannot provide a comprehensive view of a company’s financial health, but using many together alongside industry comparisons is an excellent place to start. It is encouraged to use many financial metrics to get a holistic perspective of a company’s performance, as no one metric can provide all the information you need to evaluate a company.
Frequently Asked Questions
What is the cash adjustment to EBITDA?
The cash adjustment to EBITDA involves modifying the EBITDA by adding or subtracting certain cash-based items. These could include changes in working capital, non-cash expenses, one-off gains or losses, and other items that reflect actual cash inflows and outflows.
What is the difference between cash EBITDA and adjusted EBITDA?
While both make adjustments to basic EBITDA, Adjusted EBITDA focuses on eliminating one-off, non-operational, or non-cash items, whereas Cash EBITDA emphasizes the cash flow generated from operations, making it more precise to measure liquidity and operational efficience.
What is the cash basis of EBITDA?
The cash basis of EBITDA refers to the adjustments made to EBITDA that account for actual cash inflows and outflows related to operations, emphasizing the liquidity and cash-generating capability of a business.
Is adjusted EBITDA the same as profit?
No. While profit or net income considers all revenues and expenses, Adjusted EBITA focuses specifically on operational profitability, excluding interest, taxes, depreciation, amortization, and one-off, non-operational, or non-cash items.
If you found this article useful, here are three more to view next:
Financial Leverage Ratios
How to Calculate the CAC:ARR Ratio
What is the SaaS Rule of 40?
