What is Cash-adjusted EBITDA

At some point in your SaaS journey, you will be asked about your EBITDA. And then someone will calculate your cash-adjusted EBITDA. Say what?

EBITDA represents Earnings Before Interest, Taxes, Depreciation, and Amortization. It’s a widely used measure of financial profitability. EBITDA attempts to eliminate non-cash and non-operating items. Over the long run, it measures your ability to generate cash. Of course, with GAAP accounting, there are other forces at play (rev rec, accruals, etc.). Hence, I stress the longer-term view of EBITDA.

Of course, we can’t just leave EBITDA alone in the SaaS world. We need to modify straight EBITDA with balance sheet changes.

To help avoid surprises when you discuss EBITDA with your executives, Board, and investors, I’ll break down EBITDA and cash-adjusted EBITDA. You can also download my EBITDA template below which includes a video lesson on cash-adjusted EBITDA.

What is EBITDA

EBITDA means Earnings Before Interest, Taxes, Depreciation, and Amortization. It’s a financial P&L metric that measures company profitability. It’s a widely used metric and proxy for cash generation in the long run.

It’s also a non-GAAP measure. In fact, when I searched for EBITDA in three of my graduate school finance books, it was not noted in the index.

EBITDA puts companies on a common financial basis by removing differences in tax structure (taxes at corp level, shareholder level, etc.), capital structure (debt or no debt), and capitalization policies (thresholds, capitalizing, not capitalizing).

With enough definition in our SaaS P&L, we can easily calculate EBITDA. We need the following components to calculate EBITDA.

How to Calculate EBITDA

With a properly formatted P&L, it’s fairly simple to calculate EBITDA. We find the lowest level of earnings on our P&L (usually net income or earnings before taxes) and add back the appropriate line items.

EBITDA Example #1

Check out Example #1 below. If we have net income on our P&L, we add back interest, taxes, depreciation, and amortization. You will notice that depreciation and amortization are not explicitly called out on the P&L. In that case, we need to talk to finance to get these line items.

EBITDA Example #2

It’s also important to call out the effect of R&D capitalization. In Example #2, we have the same P&L but I explicitly state the amount of R&D capitalization. We get the same EBITDA number, but is that really comparable to companies who do not capitalize their product development efforts?

I calculate an adjusted EBITDA with an addback for the R&D cap credit.

What is Cash-adjusted EBITDA

Cash-adjusted takes EBITDA one step further. We add the year-over-year change in deferred revenue from the balance sheet to EBITDA.

Cash-adjusted EBITDA is another view of EBITDA but mainly for valuation purposes . Why for valuation? Because we are trying to put our best number forward. I like to compare the concept to committed annual recurring revenue (CARR).

With CARR, we are trying to calculate the maximum value of ARR for our SaaS business at a point in time. We include ARR that has not pushed through revenue yet. It’s great for valuation and Board discussions.

It’s the same concept with cash-adjusted EBITDA. We are trying to calculate the maximum value of EBITDA by incorporating future changes that are not reflected in our current EBITDA.

I used cash-adjusted EBITDA in the private equity world where we were constantly focused on EBITDA trends. It was a preview of our upcoming EBITDA.

Cash-adjusted EBITDA Highlights

• EBITDA captures the revenue recognized by GAAP/IFRS.
• Cash Adjusted EBITDA then captures bookings that have been invoiced (increases deferred revenue) but have not yet been recognized as revenue and/or fully-impacted our TTM EBITDA.
• Cash EBITDA takes EBITDA and adds the YOY change in deferred revenue from the balance sheet.
• Receive credit for increase in deferred revenue which has not flowed into earnings yet.

How to Calculate Cash-adjusted EBITDA

To calculate cash-adjusted EBITDA, we need deferred revenue from our balance sheet and our straight EBITDA number. However, to make cash-adjusted EBITDA work, we must sum the trailing twelve months of EBITDA . And then we add the year-over-year change in deferred revenue.

The example below demonstrates the concept with two customers. We have one customer in our SaaS business and then add our second customer in Jul-21.

• In Jan-22 we have 95K of TTM EBITDA (red cell, O10).
• In Jan-22, our YOY change in deferred revenue is 25K (red cell, O16).
• We add 25K to 95K for our cash-adjusted EBITDA of 120K (green cell, O18).

Cash-adjusted EBITDA Takeaways

You can see that our TTM EBITDA is increasing with the addition of the second customer. However, in Jan-22, our EBITDA does not reflect the full impact of the second customer in our TTM EBITDA. Eventually, in Jun-22 our straight EBITDA (blue cell, T10) reflects the full impact of the second customer.

In valuation discussions, we would have not taken enough credit for our EBITDA if we only took straight TTM EBITDA at Jan-22. You may ask, can we just annualize our Jan-22 EBITDA (10K x 12 = 120K)? This proves out the math of cash-adjusted EBITDA in the example below, but it would be very dangerous to annualize one month of EBITDA as a proxy for our run-rate of EBITDA.

EBITDA versus Gross Profit

Let’s not confuse EBITDA with gross profit. Gross profit is higher on the SaaS P&L and only factors in cost of goods sold (COGS) cost centers. EBITDA takes COGS but then also factors in our operating expenses.

The P&L example below is my “EBITDA P&L.” It has interest, taxes, depreciation, and amortization already removed from the numbers. With acquisitions on my balance sheet, it was rare that I looked at a GAAP P&L. Too much non-cash accounting noise.

What is a Good EBITDA

You’ve calculated your EBITDA and cash-adjusted EBITDA numbers. What’s a good number? It depends. Your EBITDA margin depends on your goals. You may be burning cash to accelerate growth. Or you may funding operations with your own cash flow and need positive EBITDA.

This is where the Rule of 40 helps. The Rule of 40 is about the tradeoff between profit and growth.

Addbacks to EBITDA

Finally, you may hear about addbacks to EBITDA. We want EBITDA to represent our profitability from “normal,” on-going operations. If you pay for one-time, non-recurring items such as executive recruiting fees, a large consulting project, and costs of an acquisition (legal fees, audit fees), you may be able to add these back to EBITDA.

Typically, when you have debt on the balance sheet, you’ll receive a “guide” from your lender with approved add backs. Even if you do not have debt, it’s good practice to track these non-recurring items.

Takeaways

Regardless of your philosophy toward cash burn, EBITDA is an important concept to grasp. If you are burning cash, you always need to know your path to EBITDA profitability. If you are profitable, you are watching EBITDA to either reinvest as much as possible or to maximize profitability.

Cash-adjusted EBITDA takes EBITDA one step further. It’s like a preview of yet to be earned EBITDA. EBITDA is important for founders and finance to understand and monitor in their businesses.

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Cash-adjusted EBITDA video lesson.