Credit agreement add backs are an essential aspect to consider when reviewing financial documents such as credit agreements. In simple terms, they are addendum clauses that outline adjustments made to EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) calculations.
EBITDA is a useful metric in determining a company`s cash flow before accounting for non-cash expenses such as depreciation and amortization. It is widely used in credit agreements to help determine the company`s creditworthiness and ability to repay the loan. However, EBITDA alone does not always provide an accurate representation of a company`s true cash flow.
This is where credit agreement add backs come into play. They allow adjustments to be made to EBITDA, taking into account expenses that a company incurs but are not considered non-cash expenses such as restructuring charges, transaction fees, and severance payments. These expenses are added back to EBITDA to provide a more accurate representation of the company`s cash flow.
Credit agreement add backs can vary based on the specifics of each credit agreement, but they generally fall into three categories:
1. One-time expenses: These are expenses that are not expected to occur again and are not related to the company`s core business operations. Examples include severance payments, relocation expenses, and restructuring charges.
2. Non-operating expenses: These are expenses that stem from non-core business operations. Examples include gains or losses from the sale of assets and non-recurring income.
3. Non-cash expenses: These are expenses that are recorded in the company`s financial statements but do not require cash outflow. Examples include depreciation and amortization.
While credit agreement add backs can provide a more accurate representation of a company`s cash flow, it is important to note that they should not be abused. Lenders will closely scrutinize add backs to determine if they are reasonable and necessary. Add backs that are deemed frivolous or inaccurate can lead to a breach of the credit agreement and cause significant harm to the company`s creditworthiness.
In conclusion, credit agreement add backs are a crucial aspect of credit agreements that allow for adjustments to be made to EBITDA to provide a more accurate representation of a company`s cash flow. They can vary based on the specifics of each agreement, but generally, fall into three categories. It`s essential to use add backs judiciously and with the utmost care to avoid potential damage to the company`s creditworthiness.