Chapter 3/4: Non-GAAP Performance Measures

Question 1

Non-GAAP Performance Measures

Answer 1

• Used by investors, financial intermediaries, and management to evaluate performance
• If reported in 10-K and 10-Q, SEC requires reconciliation with net income

Question 2

EBITDA

Answer 2

Earnings Before interest, Taxes, Depreciation, and Amortization.

Question 3

How is EBITDA used?

Answer 3

• Used by management to evaluate performance internally.
• Used by equity analysts in valuation models.
• Used by credit analysts to evaluate default risk, financial strength, and flexibility.

Question 4

What is the purpose of EBITDA?

Answer 4

It measures the profitability of ongoing operations that are likely to be turned to cash.

Question 5

What does EBITDA strip away?

Answer 5

It strips away any effects on profit that are noncash, such as debt financing (interest) and the effects of noncash accounting conventions (depreciation and amortization).

Question 6

What are the limitations of EBITDA?

Answer 6

It ignores the need for capital expenditures to maintain and replace PP&E and there is no standard method of calculation.

Question 7

What are common adjustments?

Answer 7

• Stock-based compensation (noncash expense)
• Significant one time gains or losses (transitory)

Question 8

What do companies disclose it as?

Answer 8

Adjusted EBITDA.

Question 9

EBITDA Margin Formula

Answer 9

EBITDA (adjusted) / Revenue

Question 10

What is EBIT?

Answer 10

Earnings Before Interest and Taxes. Similar to EBITDA but without depreciation and amortization adjustments.

Question 11

EBIT Formula

Answer 11

Net Income + interest expense + income tax expense

Question 12

What is Free Cash Flow (FCF)?

Answer 12

The amount of money that is leftover after paying for operations and maintaining capital assets (PP&E and intangibles).

Question 13

How to calculate Free Cash Flow (FCF)?

Answer 13

Operating Cash Flow - Capital Expenditures (Investing activities, PP&E, Intangibles).

Question 14

Unlevered Free Cash Flow (FCFF), aka Enterprise Free Cash Flow

Answer 14

Removes the effect of interest expense (net of tax) from the FCF metric.

Question 15

Why does Enterprise Free Cash Flow (FCFF) remove the effect of interest expense?

Answer 15

Entities have flexibility in how much debt they report on their balance sheets, and FCFF strips away the effects of that choice, and can provide a more consistent measure for comparisons.

Question 16

How to calculate FCFF?

Answer 16

EBIT - implied income tax expense (on EBIT) +- noncash expenses, revenues, gains, or losses (D&A, stock comp, etc) +- Change in net (noncash) working capital (OA_OL) - Capital Expenditures (CapEX)