Christian Debt Recovery

Cash After Debt Amortization Formula

February 1st, 2010 |

Author: Gavin

EBITDA and Pharmacy Acquisitions in the State of Nevada

Generally, EBITDA makes it easier to evaluate various companies and to compare them against industry averages by removing the non-core and irregular operating costs, such as interest, which can vary depending on the management’s choice of financing, taxes which can fluctuate depending on acquisitions or losses from prior years, and arbitrary factors of depreciation and amortization.

The EBITDA formula can be used as a guideline when valuing larger companies, or when comparing the profitability of large similar companies in the same industry.

For the effective use of EBITDA, these larger companies should possess significant assets, have heavy amortization schedules, or bear substantial amounts of debt. Considering independent pharmacies don’t meet that criteria, this formula is not a useful measure as the sole means for valuing pharmacies for acquisition purposes.

To Calculate EBITDA:
1. Calculate net income by obtaining total income and subtract total expenses.
2. Determine the total amount of taxes paid to federal, state, and local governments.
3. Compute interest fees paid to companies or individuals for the use of credit, or capital.
4. Establish the cost of depreciation (the expense recorded to allocate a tangible asset’s cost over its useful life).
5. Determine the cost of amortization (the expense for consumption of the value of intangible assets, such as goodwill, patents, and copyrights, over a specific period of time, or the asset’s expected life.
6. Add #1 through #5.

EBITDA calculation example:
1. Net Income            1,000
2. + Taxes paid            300
3. + Interest Expenses 200
4. + Depreciation          100
5. + Amortization             50
6. = EBITDA           1,650

Drawbacks of EBITDA:
1. Can be misleading number when it is confused with cash flow.
2. Can make even completely unprofitable firms appear to be financially healthy.
3. Numbers are easy to manipulate.
4. Can overlook cash requirements for growth in accounts receivable.
5. Can miss cash requirements for growth in inventories.
6. Not factual when valuing small companies.
7. Not effective for companies with few assets, small amounts of debt, or low depreciation or amortization schedules.

EBITDA was used a proxy for cash flow during the 1980s for leveraged buyouts in order to calculate whether or not companies could service their debt. Factoring out taxes, interest, amortization, and depreciation can make unprofitable businesses appear to be financially healthy. This valuation method was also used extensively during the dotcom boom to value unprofitable businesses with little earnings and few assets. This was a blaring example of misusing EBITDA, and the result from using this method caused many businesses to go bust.

Well-informed pharmacy specialists who perform Nevada pharmacy business valuations regularly will use EBITDA in their valuations, but only when its part of a larger formula when computing values for niche pharmacies with a specialty in long term care, HIV, disease management, etc. Despite this, EBITDA should not be used as part of the usual formula when performing standard retail pharmacy acquisitions in Nevada.

In most cases, the EBITDA number for existing pharmacies is important when the current ownership is establishing the value of their Nevada store for the purpose of a credit line, to create a trust, for borrowing, stock values, etc., but EBITDA does not have the same weight when the pharmacy is being sold. This is because the expenses of the buyer and seller will be different.

Because buyers might not have the same interest expenses, tax base, or depreciation schedule, it is crucial that buyers calculate an estimated EBITDA that is catered towards their own operating model, business system power, cost of operations, cost of operations, and other financial factors instead of the seller’s. Note that EBITDA assumes the buyer will acquire all assets, working capital, liabilities, and accounts receivable, and those assumptions are not applicable when acquiring a Nevada pharmacy. Instead of using the EBITDA number, pharmacy buyers should focus on cash flow, gross profit, customer mix, and overall sales.

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Resource Box

Contact pharmacy industry specialists at www.WashburnAndAssociates.com when you require information on current market valuation of a pharmacy business in Nevada.

You have permission to reprint this article provided this resource box is kept unchanged and included with the article.

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