The Impact of CAPEX on EBITDA Adjustments

Earnings before interest, tax, depreciation, and amortization (EBITDA) is the measure of a company’s cash flow, calculated as:

• Net income before taxes + Interest on long-term debt + depreciation and amortization

EBITDA offers a window into the value of a company for potential buyers and investors, indicating future growth opportunities for the company. Business owners, buyers, private equity investors, and analysts worldwide commonly use this formula to compare profitability between similar businesses and sectors while eliminating other accounting factors such as financing or government impacts. It is a helpful tool that gives an overview of a business’s value and can also be used as an alternative for cash flow.

An EBITDA multiple compares a company’s annual EBITDA with its overall enterprise value (EV), and it is also used to compare it with similar businesses using the following formula:

• EBITDA Multiple = Enterprise Value / EBITDA

Normalized EBITDA

Smaller, privately owned businesses usually need to make additional adjustments to EBITDA to account for revenues or expenses that are non-typical or non-recurring, as well as revenues or expenses that are related to the owner but not to the company itself. This is known as normalized EBITDA or adjusted EBITDA.

The Impact of CAPEX

Capital expenditures are related to the company's purchasing of physical assets or equipment. The cost is capitalized as property, plant, and equipment (PP&E) and depreciated over the asset’s expected term of use. Depreciation expenses are added back to net income in order to calculate EBITDA, so CAPEX is excluded.

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While EBITDA is commonly used as a proxy for net cash flow, it is important to keep in mind that EBITDA is not equal to net cash flow. CAPEX, or capital expenditures, reduce the net cash flow of a business but are NOT factored into EBITDA calculations since they do not affect the profits and loss statements. Also, as a business grows, it usually requires investments into higher levels of receivables, inventories, and other working capital assets to contribute to higher revenue levels. This includes maintenance or upgrades to operating equipment, which varies between businesses and industries. Such investments are a use of future cash and are not reflected in EBITDA calculations. Service businesses do not typically have high levels of investment in operating equipment like a construction company or manufacturer may have.

CAPEX Versus OPEX

With CAPEX, expenditures are accounted for as fixed assets on the business’s balance sheet. They are often used for longer than 12 months and contribute to the company’s overall value but will depreciate with wear and tear over time, which is a non-cash expense. Also, there are tax deductions for capital expenditures, which spread the tax benefit across the asset’s term of life, incentivizing companies to invest in the future while still enjoying tax breaks.

Operating expenses (OpEx) are immediately expensed on the income statement as a cash outflow, affecting a business’s net income and impacting its short-term profitability. While OpEx is usually tax-deductible, it does not have the same expanded benefits as CapEx. It’s more about the company's day-to-day operations and how it is used to keep it running smoothly.

There are asset purchases related to CAPEX that do immediately show up on an income statement, such as a business vehicle. While the purchase of the vehicle is not recorded on the income statement for that year, other costs, such as fuel, insurance, and maintenance, are considered business expenses. These expenses can also be offset by revenue growth resulting from boosted sales activity using the new vehicle.

Capital expenditures can have a significant impact on both the short-term and long-term financial standing of a business, so decisions related to CAPEX are critical for the financial health of the company. It is common for businesses to focus on maintaining their historical CAPEX levels to prove to investors that they are committed to investing in the growth of the organization, which is always good when selling a company because it contributes to higher buyer confidence as well as higher company valuations. In any case, when it comes to capital expenditures, it is important to always think about the long-term picture based on accurate data capture and future planning.

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