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When is EBIT not EBIT?

Firstly, why use EBIT for valuation purposes? Essentially it’s because potential purchasers will have different financing structures and different tax circumstances, and using EBIT as the earnings measure means offers can be evaluated on a level footing. So far, so simple, but let’s dig a bit deeper what measure of EBIT do we use - just the reported figure? Or is it perhaps more nuanced than that? When looking at private companies, the answer is normally the latter.

For many private companies there will be expenditure items that are closely associated with the owners – for example the leasing of expensive cars, conveniently located office space, or directors’ remuneration packages that a purchaser will not have to continue with. On the flip side, many business owners choose to take a low salary and top that up with dividends. Those dividends will not be included within a reported EBIT figure and to consequently reflect the true cost to the business of the owners’ contribution an additional cost would need to be included. 

Similarly, a company may have reported a windfall from an asset sale, or a significant hit to the P&L in a financial year because of, say, redundancy payments or to settle litigation. These are, one would expect, one-off in nature, and as non-recurring items, could be argued to be legitimate adjustments to the reported EBIT figure when contemplating a future maintainable level of earnings.

The desired outcome for both buyer and seller is to arrive a reasonable approximation to that maintainable (or, if you prefer, sustainable) level of EBIT as this is going to be the best indicator of future cash generation.

There are many more examples and the relevance (or otherwise) of these will vary according to the circumstances of both the buyer and the seller. It’s generally true though that the more points of principle are agreed within the Heads of Terms, the better.

The calculation of maintainable EBIT is important to a deal because of the multiplier effect of course, and whilst a debate about a market equivalent rate for a management team might, on the face of it, appear to be about £100K a year, when there’s a multiple of 10 in play, the potential difference to EV is £1m. It should go without saying therefore that it’s well worth engaging the services of experienced professionals how can help you navigate what can sometimes be troubled waters.

The next steps

If you would like a quick initial discussion about how we can support you in the maintainable EBIT discussion, or in the deal arena more generally, please get in touch with James Price on or your usual UHY adviser.

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