Hi guys:
Could someone please explain the concept of Cash EBITDA for software business, and why it's so important for software business models please? Keep hearing about it but not sure I understand.
Thank you
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Cash EBITDA is = EBITDA + change in deferred revenue - capitalized costs. Its a better indicator of pretax cashflow than just EBITDA alone
Cash EBITDA takes EBITDA and adds the YOY change in deferred revenue from the balance sheet. Therefore, Cash EBITDA captures increased bookings (increase in deferred).
Thus you’re giving value to a likely form of future revenue that hasn’t been booked as revenue just get. “Giving value for tomorrow’s earned revenue today, for what’s been worked on yesterday.”
Breaking down the components a bit more - in software land, deferred revenue arises when there is a mismatch between billing terms and revenue recognition terms. Frequently, a customer may be billed their entire subscription annually upfront (e.g., 12 months of revenue billed in January), but SaaS revenue recognition dictates that the revenue can only be recognized one month at a time. The deferred revenue balance for that client will roll-off over the next 12 months as revenue catches up with cash received.
Cash EBITDA combines normal adjusted EBITDA plus the change in this deferred revenue balance (i.e., compare current balance on BS to last year and take the incremental) to identify incremental cash flow from clients that is not yet represented on the P&L due to rev rec timing.
Thank you, this is really helpful! I have a follow-up question if you don't mind:
For On-premise software, aka the software that charge a large upfront installation fee, and then small annual recurring upgrade fees - would there also be deferred revenue component? Thanks!
It depends.
If it is a perpetual license with maintenance revenue, 100% of revenue could be recognized at the time of the sale (as the service can be considered as performed). For the maintenance revenue: either 100% recognized as revenue upon collection on ratably over time (in which case it raises DR in your balance sheet).
Note that from a valuation perspective, perpetual license with maintenance revenue is not a coveted as 100% recurring revenue.
Your company may soon realize that converting perpetual licenses to term/subscription may prove benefitial from a valuation perspective.
It becomes a headaches to balance things out as perpetual licenses provide a large chunk of cash upfront while 100% recurring or term/subscription licenses are better in the long run BUT are putting financial stress on the company.
Also, do you mind walking through how accounting / revenue recognition differs from Saas vs on-premise software?
There can be nuances, but on-premise (license/maintenance) usually has a license component that is paid upfront and revenue is recognized all at once (so no deferred revenue created). The maintenance component is similar to SaaS where it is recognized monthly and could be billed annually (which would create deferred revenue) or monthly (seemingly more standard).
Change in DR like others have mentioned is big, capitalized software is the other big reason.
Capitalized software let’s companies book a portion of software development costs of new product development as capex so they aren’t a P&L expense (but are still a cash outlay). Tech PE firms can get a bit ridiculous with this and capitalize the majority of their R&D every year, which artificially inflates EBITDA but doesn’t accurately represent cash situation.
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