Below the Surface: the Neglected Parts
Items below EBITDA
Often in a financial due diligence, the analysis is done until EBITDA which is the relevant operational indicator. Items below EBITDA can “easily” be changed depending on the tax environment, the financing structure, and the asset base. But understanding the items below EBITDA helps understand what happens between EBITDA and net income.
In the following article, I am going to discuss the items below EBITDA.
Depreciation and amortization
Depreciation and amortization apply to fixed and intangible assets. The amount depends on the company’s asset management. Does the company own machines? Or does it use suppliers to manufacture them? Does it expense items or recognize them as assets? The accounting principles allow for fluctuations, i.e. depreciation for asset X can be over three to five years. Hence, the amount is also dependent on which time frame was chosen.
Interest
Interest expenses apply to bank loans or any other debt. Interest income from financial assets, e.g. the purchase of shares, is also reported here. This line item can be changed since the acquirer can choose its financial structure. Also, this line is indirectly analyzed in the net debt discussion.
Tax
Taxes relate to the income and corporate taxes that a company needs to pay. Also here, an acquirer can change the underlying tax structure.
Other aspects
- If the company is part of a larger corporation, it might have a P&L transfer agreement with the parent company.
Key takeaways
- Typically no operational figures but rather chosen strategically: which financing and which tax structure does the company want to install?
- These items can be changed rather easy via changes in the company’s asset management, financing, and tax structure
Final thoughts
Items below EBITDA form the bridge from EBITDA to net income and can be material in size. The focus of a financial due diligence is on understanding the operational environment. Items below EBITDA are rather strategic figures. A potential investor can adjust these figures to its own and specific structure.
