What is the actual useable EBITDA from a tax return

July 27, 2024

by a searcher from Oregon State University in Monterey, CA, USA

How does one determine a REAL WORLD cash flow from the tax return. Is there a universal line item or formula to use from the 1120?

Assuming I'm using significant leverage, what is really there to support debt payments? Thus far I've heard from different sources to use M1-1, M1-10, or 1120 "taxable income" as the starting point for addbacks. Would love to get some alternative perspectives from the financiers on the forum.

For context, Im coming from the public markets, so have only ever used financial statements to do analysis. I'm trying to be able to understand how it translates to the tax returns that banks utilize.

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Reply by a lender
from Trinity College Connecticut in Boston, MA, USA

Tax returns are used because they can be verified with the IRS and the SBA requires that verification to be done. Start with the Net Income from the 3 prior tax returns and addback the normal/easily acceptable addbacks of Owners Compensation, Depreciation & Amortization, and Interest Expense. There may also be other addbacks and one-time expenses that can be documented as addbacks. Those get you to Seller Discretionary Earnings, where you then need to subtract what the Buyer is going to pay himself as compensation, and what income taxes will need to be paid (either by a C-Corp, or distributed to LLC or S-Corp owners to cover their personal taxes on the income passed through on K-1's). The net is what you use to calculate the Debt Service Coverage Ratio (DSCR), which we want to see meet a minimum 1.15 DSCR, at least for the most recent full year and with the Interim financials. Always available to discuss. Thanks

Reply by an intermediary
from Iowa State University in Kansas City, MO, USA

Initially, I use a company's internal P&Ls to model historical and future cash flows and to assess the viability of a business transaction. In an average deal, I'm only using tax returns as a means to verify and cross-check with the books, as well as some of the claimed add-backs. If I find discrepancies between the books and the tax returns, that's going to give some further insight into the deal and let me know additional diligence is required.

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