Correct way to model EBITDA?
In a LBO where you are using projections from a full P&L build (i.e. actually calculating each line item like COGS and building down, instead of just assuming a margin to get to EBITDA or something), isn't it necessary to strip D&A out of all the cost lines to accurately project EBITDA?
I've seen some people build down to EBIT and then just add back D&A to get back to EBITDA in the projection period, but conceptually this doesn't seem right to me because then your EBITDA is increasing when D&A is increasing (rather, EBIT should be decreasing and EBITDA staying flat, right?). Plus, if you start your FCF build from EBITDA then, aren't you inflating your free cash flow?
Is the reason some people model it this way because they don't have the D&A breakout by cost item and they don't want to estimate?
Just trying to wrap my head around this to see if I'm missing something, any input is much appreciated
Yes there are 2 methods to get to EBITDA, a top-down approach and a bottom-up approach. The top-down approach is more intellectually honest but more difficult/time-consuming, so many people resort to the bottom-up approach. The top-down approach is where you extract D&A from each operating expense line, so that none of the Opex include any D&A. The bottom-up approach is basically taking EBIT and adding back D&A (plus any other addbacks you may want, but that is irrelevant to your question).
As you mentioned, this bottom-up approach can lead to some inaccuracies in your model when doing sensitivity analyses or adjusting your assumptions in general. However, it is also much faster, so I think it comes down to a value judgement and how much time you have.
Thanks! I'm just a little confused because I'm looking at some super in-depth models that use the bottom-up approach - do you think it's done to avoid having to make estimates about how D&A is embedded in cost line items? Just trying to wrap my head around why that would be the case
Yes I think it is because of a lack of info. Many companies do not explicitly break out how D&A factor into each opex line. As a result, you can either make guesses, or just do bottom-up approach and hopefully make a note somewhere that you are doing it that way.
for a model test i would do the following
Revenue (driven by higher/ lower growth rates depending on case) COGS (difference between GP and Revenue) GP (driven by higher/ lower margin depending on case) Opex (depending on case) Ebitda Less: D&A (driven by D&a schedule or % revenue; or equal to capex) Ebit
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