Acuity Blog

Look beyond EBITDA

Acronym EBITDA on wood planks

Earnings before interest, taxes, depreciation and amortization (EBITDA) is commonly used to assess financial health and evaluate investment decisions. But sometimes this metric overstates a company’s true performance, ability to service debt, and value. That’s why internal and external stakeholders should exercise caution when reviewing EBITDA.

History of EBITDA

The market’s preoccupation with EBITDA started during the leveraged buyout craze of the 1980s. The metric was especially popular among public companies in capital-intensive industries, such as steel, wireless communications and cable television. Many EBITDA proponents claim it provides a clearer view of long-term financial performance, because EBITDA generally excludes nonrecurring events and one-time capital expenditures.

Today, EBITDA is the third most quoted performance metric — behind earnings per share and operating cash flow — in the “management discussion and analysis” section of public companies’ annual financial statements. The corporate obsession with EBITDA has also infiltrated smaller, private entities that tend to use oversimplified EBITDA pricing multiples in mergers and acquisitions. And it’s provided technology and telecommunication companies with a convenient way to dress up lackluster performance.

Inconsistent definitions

EBITDA isn’t recognized under U.S. Generally Accepted Accounting Principles (GAAP) or by the Securities and Exchange Commission (SEC) as a measure of profitability or cash flow. Without formal guidance, companies have been free to define EBITDA any way they choose — which can make it difficult to assess company performance.

For example, some analysts when calculating EBITDA subtract nonrecurring and extraordinary business charges, such as goodwill impairment, restructuring expenses, and the cost of long-term incentive compensation and stock option plans. Others, however, subtract none or only some of those charges. Therefore, comparing EBITDA between companies can be like comparing apples and oranges.

Moreover, the metric fails to consider changes in working capital requirements, income taxes, principal repayments and capital expenditures. When used in mergers and acquisitions, EBITDA pricing multiples generally fail to address the company’s asset management efficiency, the condition and use of its fixed assets, or the existence of nonoperating assets and unrecorded liabilities. In fact, many high profile accounting scandals and bankruptcies have been linked to the misuse of EBITDA, including those involving WorldCom, Cablevision, Vivendi, Enron and Sunbeam.

Balancing act

Despite these shortcomings, EBITDA isn’t all bad. It can provide insight when used in conjunction with more traditional metrics, such as cash flow, net income and return on investment. For help performing comprehensive due diligence that looks beyond EBITDA, contact us.

© 2017

 


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All fringe benefits aren’t created equal for tax purposes

Benefits Word Means Perks Bonuses Or Reward

According to IRS Publication 5137, Fringe Benefit Guide, a fringe benefit is “a form of pay (including property, services, cash or cash equivalent), in addition to stated pay, for the performance of services.” But the tax treatment of a fringe benefit can vary dramatically based on the type of benefit.

Generally, the IRS takes one of four tax approaches to fringe benefits:

  1. Taxable/includable. The value of benefits in this category are taxable because they must be included in employees’ gross income as wages and reported on Form W-2. They’re usually also subject to federal income tax withholding, Social Security tax (unless the employee has already reached the current year Social Security wage base limit) and Medicare tax. Typical examples include cash bonuses and the personal use of a company vehicle.
  2. Nontaxable/excludable. Benefits in this category are considered nontaxable because you may exclude them from employees’ wages under a specific section of the Internal Revenue Code. Examples include:
  • Working-condition fringe benefits, which are expenses that, if employees had paid for the item themselves, could have been deducted on their personal tax returns (such as subscriptions to business periodicals or websites and some types of on-the-job training),
  • De minimis fringe benefits, which include any employer-provided property or service that has a value so small that accounting for it is “unreasonable or administratively impracticable” (such as occasional coffee, doughnuts or soft drinks and permission to make occasional local telephone calls),
  • Properly documented work-related travel expenses (such as transportation and lodging),
  • Up to $50,000 in group term-life insurance, as long as the policy meets certain IRS requirements, and
  • Employer-paid health care premiums under a qualifying plan.
  1. Partially taxable. In some cases, the value of a fringe benefit will be excluded under an IRC section up to a certain dollar limit with the remainder taxable. A public transportation subsidy under Section 132 is one example.
  2. Tax-deferred. This designation applies to fringe benefits that aren’t taxable when received but that will be subject to tax later. A common example is employer contributions to a defined contribution plan, such as a 401(k) plan.

Are you applying the proper tax treatment to each fringe benefit you provide? If not, you could face unexpected tax liabilities or other undesirable consequences. Please contact us with any questions you have about the proper tax treatment of a particular benefit you currently offer or are considering offering.

© 2017


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Less than 6 months until the new contract revenue guidance goes live!

do it - procrastination concept

The sweeping new revenue recognition standard goes into effect soon. But many companies are behind on implementing it. Whether your company is public or private, you can’t afford to delay the implementation process any longer.

5 steps

Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, requires companies following U.S. Generally Accepted Accounting Principles (GAAP) to use a principles-based approach for recognizing revenues from long-term contracts. Under the new guidance, companies must follow five steps when deciding how and when to recognize revenues:

  1. Identify a contract with a customer.
  2. Separate the contract’s commitments.
  3. Determine the transaction price.
  4. Allocate a price to each promise.
  5. Recognize revenue when or as the company transfers the promised good or service to the customer, depending on the type of contract.

In some cases, the new guidance will result in earlier revenue recognition than in current practice. This is because the new standard will require companies to estimate the effects of sales incentives, discounts and warranties.

Changes coming

The new standard goes into effect for public companies next year. Private companies have a one-year reprieve.

The breadth of change that will be experienced from the new standard depends on the industry. Companies that currently follow specific industry-based guidance, such as software, real estate, asset management and wireless carrier companies, will feel the biggest changes. Nearly all companies will be affected by the expanded disclosure requirements.

Some companies that have already started the implementation process have found that it’s more challenging than they initially expected, especially if the company issues comparative statements. Reporting comparative results in accordance with the new standard requires a two-year head start to ensure all of the relevant data is accurately collected.

Reasons for procrastination

Why are so many companies dragging their feet? Reasons may include:

  • Lack of funding or staff,
  • Challenges interpreting the standard’s technical requirements, and
  • Difficulty collecting data.

Many companies remain uncertain how to prepare their accounting systems and recordkeeping to accommodate the changes, even though the FASB has issued several amendments to help clarify the guidance. In addition, the AICPA’s FinREC has published industry-specific interpretive guidance to address specific implementation issues related to the revenue recognition standard.

Got contracts?

We’ve already helped other companies start the implementation process — and we’re ready to help get you up to speed, too. Contact us for questions on how the new revenue recognition standard will impact your financial statements and accounting systems.

© 2017


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Keep real estate separate from your business’s corporate assets to save tax

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It’s common for a business to own not only typical business assets, such as equipment, inventory and furnishings, but also the building where the business operates — and possibly other real estate as well. There can, however, be negative consequences when a business’s real estate is included in its general corporate assets. By holding real estate in a separate entity, owners can save tax and enjoy other benefits, too.

Capturing tax savings

Many businesses operate as C corporations so they can buy and hold real estate just as they do equipment, inventory and other assets. The expenses of owning the property are treated as ordinary expenses on the company’s income statement. However, if the real estate is sold, any profit is subject to double taxation: first at the corporate level and then at the owner’s individual level when a distribution is made. As a result, putting real estate in a C corporation can be a costly mistake.

If the real estate is held instead by the business owner(s) or in a pass-through entity, such as a limited liability company (LLC) or limited partnership, and then leased to the corporation, the profit on a sale of the property is taxed only once — at the individual level.

LLC: The entity of choice

The most straightforward and seemingly least expensive way for an owner to maximize the tax benefits is to buy the real estate outright. However, this could transfer liabilities related to the property (such as for injuries suffered on the property) directly to the owner, putting other assets — including the business — at risk. In essence, it would negate part of the rationale for organizing the business as a corporation in the first place.

So, it’s generally best to put real estate in its own limited liability entity. The LLC is most often the vehicle of choice for this. Limited partnerships can accomplish the same ends if there are multiple owners, but the disadvantage is that you’ll incur more expense by having to set up two entities: the partnership itself and typically a corporation to serve as the general partner.

We can help you create a plan of ownership for real estate that best suits your situation.

© 2017

 


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