Amortization as an Add-Back?

June 01, 2023

by a searcher from University of Virginia-Darden - Darden School of Business in Richmond, VA, USA

In our world, so much depends on valuing a company well. And usually I look at some combination of discounted cash flows and EBITDA. I've bought a couple companies now but there's still something I don't understand. When you see "amortization" in the add-backs is that amortization of some asset the business has or some loan? I have seen sellers and brokers try to add-back both but the amortization dollars to pay off a loan are already captured in the starting point of net income. So that makes no sense to me and it appears they're double counting it toward EBITDA. If it's the former, that makes some sense I guess. The reason I asked this is that I recently saw a CIM with huge add-backs and thought I'd bring the point up before a bunch of smart minds.

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Reply by a searcher
from University of Pennsylvania in Charlotte, NC, USA

Good points above. A nuance worth mentioning: as noted above goodwill amortization is tax deductible (15 years generally), but goodwill is not amortized per GAAP. As such, it should not be a book expense to begin with and therefore regardless what the tax return shows, it's not an accounting addback. Unless it was mistakenly recorded as an accounting expense. Non-goodwill intangibles with definite useful economic lives are usually amortized for book purposes over their lives, and as noted multiple times above, are addbacks. Likewise capitalized loan fees/costs. The good point is made above that for analytic purposes, you may not want to count the A as an addback if you as new owner are going to face necessary expenditures to replace that intangible asset - contract, license, etc. Same as determining how much D you want to count as an addback when you'll have a near term and/or recurring capex need to replace the depreciated assets. All this almost sidesteps Bruce's original question which centers on valuation - if you're doing a DCF analysis, it's not EBITDA you're looking at but rather after tax EBIT in which you'll consider the tax attributes of the transaction since you add back amortization on an after tax basis (+ depreciation +/- change in WC - capex).

Reply by an intermediary
from The University of Chicago in Chicago, IL, USA

The confusion is that the word "amortization" has two meanings. ^redacted‌ has explained well.
The intangible asset amortization (X) reduces the intangible asset value on left side of the balance sheet, X is a non-cash expense in P&L and hence IS an add-back.
The loam amortization (Y) is a debt principal repayment. It reduces the outstanding loan on the right side of the balance sheet. Y is not an expense item; on the P&L and is NOT an add-back. (Edit: Adding this after reading ^redacted‌ comment: To the extent, Y has been deducted as an expense in P&L, knowing or unknowingly, Y should be added back in calculating adjusted EBITDA because, had Y not been expensed, the reported profit would been higher.)
I have seen 1000+ CIMs prepared by other brokers. I have also done add-backs for 1000+ sellers. I have not run into a broker and/or seller adding both X and Y,
See example below:
I once represented a glass trophy blank mfg. business. Seller bought equipment and grinding wheels (and other supply items) from the same distributor. Business was growing. One additional equipment was purchased on a capital lease, but it was not put on the balance sheet (an unintentional error). Seller paid one combined monthly payment to the distributor for supplies and loan repayment. Accountant thought all payments were for consumable supplies and expensed all. This kind of unintentional error does occur in SMB where many sellers do not have finance background.).

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