Overview

This is an area where we have done countless sessions of training with brokers around the country, and continues to prove a challenge.  Therefore we will try and create a simple overview, but do feel free to contact us with your questions.

EBITDA stands for Earnings Before Interest Tax Depreciation and Amortisation.  This is very much an accounting term and in the world of lending it is actually used slightly differently depending on the finance being requested.  There are also other elements which come into play here which then gives us an Adjusted EBITDA.

So what is it we are trying to reach?  Well in essence it is the level of profitability which the business is making that can be used to service the finance being requested.  This adjusted EBITDA is then compared to the annual finance payments, to ensure that the level of Debt Service Coverage (DSC) is met by a minimum level:

For example:

Adjusted EBITDA 75,000

Annual Finance Payments        50,000

DSC 150%

Although be mindful that all finance payments will generally need to be taken into account.

Why use EBITDA?

The use of this calculation by lenders is effectively to look at previous years financial performance, to see if the proposed facility would have been affordable historically.  The simple premise is that if a business could afford it historically, then they can probably afford it in the future.

This can of course be a challenge when we are dealing with new businesses, or significant events such as COVID and how this has negatively impacted a great many businesses.  However this is not always a clear barrier, as lenders take market issues into account when looking back, and if you have accountant produced forecast, then these can go some way in mitigating lender concerns.

Required Information

You will need the full financial accounts, and you should really do this for a minimum of 3 years.

Earnings Before (E) - This is effectively the Profit after Tax (but Before Dividends).

Interest (I) - You should only include the interest if this relates to debt that you are refinancing.  Accountants will typically add back all interest here.

Tax (T) - This is simply the amount of tax paid in the financial year.

Depreciation (D) - This is the depreciation charged for the year in question, which relates to the Tangible Assets (stuff you can touch) within the business.

Amortisation (A) - Very similar to the depreciation, however this is stuff you cant touch, typically Goodwill.

To make this an Adjusted EBITDA we would typically add in two further elements:

Rent (R) - If you are moving from rented to owned, then your rental payments can of course now contribute to the mortgage payments.  You should only add back any rent that is being replaced, if it will continue into the future (say buying a new premises but keeping the rented as well), then you would leave it in.  Also, consider how your Business Rates bill may be affected.  If this is likely to materially move then you might want to include this movement.

Dividends (Div) - Whilst dividends are technically discretionary, the reality is that due to the tax benefits Directors will take a portion of their income in the form of Dividends.  Therefore this is effectively the same as salary and therefore should reduce the profits from a lenders perspective with affordability.  This can be challenging where directors have taken higher dividends than needed, either constantly or exceptionally, so very much worth discussing.

How To Calculate

Now we know the numbers, the calculation for the Adjusted EBITDA figure is:

E + I + T + D + A + R - Div

As discussed previously, you would really want this figure to be at very least 125% of the proposed Annual Debt Payments going forward.