From Adjusted EBITDA to EBITDA less Maintenance Capex

EBITDA is earnings before the business replaces anything. Leaving out depreciation and amortization makes businesses with different accounting choices easier to compare, and it also leaves out the trucks that wear out, the machines that need overhauls and the roof that will need replacing. A business can report the same EBITDA for years while its equipment ages toward a year in which much of it has to be replaced at once. The first span of the third bridge brings that spending back into view and divides it into two kinds that a buyer treats very differently.

What the measure is

The measure this span reaches is EBITDA less maintenance capital spending: earnings after the spending that keeps the business running at its current capacity, separated from the spending that grows it. Maintenance capital spending replaces or restores capacity the business already has. Growth capital spending adds capacity: a new line, a new location, a second crew's equipment.

Maintenance is a cost of standing still. A business that stopped it would shrink, so a buyer deducts it from earnings in full, every year, as surely as wages. Growth spending is an investment that produces more revenue, and a buyer judges it by the return it earns. The two can look identical on an invoice, which is why the business has to be able to say which is which.

Why a buyer deducts the larger figure

A buyer who cannot tell the two apart assumes the worst. Without a documented split, a diligence team rebuilds one from the ledger, finds it cannot be sure which purchases were growth, and deducts the larger of its own estimate or depreciation, usually treating most capital spending as the cost of standing still.

The framework counts this as a price effect. In the illustration, the business spends $400,000 a year on capital items either way. With no split, a buyer deducts all of it. With a documented split showing that 45 percent was maintenance, the buyer deducts $180,000 and credits the rest as investment in growth, and at an illustrative multiple the difference in price is large. The business's cash is the same in both cases; only the buyer's belief has moved, and the framework records that in its own column instead of counting it as value.

The value on this span comes from spending the business avoids. A maintenance policy that stops items being bought early or capitalized twice, and a plan that replaces assets on a schedule before they fail, change what the business pays, and those are the moves the framework counts.

The two drivers

Capex Discipline settles what counts as capital spending. A written capitalization policy, approved by the outside accountant, sets the dollar floor, the useful lives and the line between a repair and an improvement, and three years of history are restated to it. Every capital item above the floor is then listed with its invoice and its classification, and average maintenance spending is reconciled to depreciation, with each gap explained by asset class.

Asset Stewardship looks at what the business runs on. It builds a fixed-asset register that ties to the ledger and has been checked against what is physically there within the year, has every material asset rated for condition and remaining life by someone qualified other than the owner, and turns the ratings into a five-year replacement plan at today's costs, with overdue maintenance done or priced.

Why both are needed

Capex Discipline reads the past, what the business has spent and on what. Asset Stewardship reads the future, what the assets will need and when. A buyer needs both, because three years of history can mislead on its own.

A business whose equipment is young can show low maintenance spending for three years and then face a year in which several large assets reach the end of their lives together. A business that has been deferring maintenance to protect its earnings shows low spending for exactly the wrong reason. Either way the history understates what the next owner will have to spend, and a buyer's engineer who walks the site will find it. The replacement plan answers the engineer's question before the engineer arrives.

The order matters too. Asset Stewardship builds its register to the policy's floor and asset classes, so the policy has to come first or the register will not tie to the ledger. Both drivers also lean on the second bridge. The capital spending history is a reading of three years of reviewed accrual statements, which cannot be split on cash-basis books, and the register needs someone other than the owner responsible for each class of asset, which Management Install provided.

The estimate this span replaces

The maintenance figure has been in the business's valuation since the first anchor. At SDE and again at adjusted EBITDA, the value of the business with no growth was its cash flow after the spending that keeps the assets working. That spending was estimated: annual depreciation, adjusted asset by asset for age and condition, with a one-line reason for each adjustment, and labelled in so many words as an estimate this span's classification would replace.

Here the replacement happens. The estimate gives way to a classified record of three years of capital spending, reconciled to depreciation with every gap explained, and to a forward plan built from qualified ratings of each material asset. The earnings power value at the next anchor deducts the recorded and planned figure, and where it differs from the old estimate, the value moves by the difference, capitalized at the cost of capital.

In the illustration, an estimate of $210,000 a year gives way to a recorded and planned figure of $180,000, which at a 12 percent cost of capital adds $250,000 to earnings power value and takes nothing away. Had the record come in above the estimate, the same arithmetic would have lowered the value instead.

The difference can go either way. A business whose assets are in better condition than their age suggests sees its maintenance deduction fall. One that has been deferring maintenance sees it rise, sometimes sharply, once the overdue work is priced. In both cases the figure is now the business's own, sourced and defensible, and a buyer can no longer swap in a harsher one.

What the owner has to accept

The span asks the owner to accept two things that can feel like losses. Some of what was capitalized should have been expensed, and some of what was called growth was maintenance. Restating three years to a consistent policy often lowers past EBITDA a little, because repairs capitalized in good years come back into the expenses. And the equipment is probably older, or in worse condition, than the owner would like to believe, so a priced plan to replace it will show a real cost in the years ahead. Both lower the numbers on paper, and a buyer would have found both anyway. Finding them first gives the owner the chance to explain them, plan for them or fix them.

How the span comes undone

The policy can bend to flatter a year, with repairs capitalized when earnings need help and expensed when they do not. The asset register can go stale as equipment is bought, sold and scrapped. And maintenance can be deferred, a saving that flatters the year and is paid for later, usually at a higher price. The two driver essays describe what holds each in place; what they have in common is that every one of these drifts is made visible at the moment it happens, through the accountant's engagement, the purchase approval, the annual count and the budget.

Crossing the span

The span is crossed when a capital spending schedule distinguishes keeping the business running from growing it and a buyer accepts the split, and when the assets the business runs on are registered, rated and on a replacement plan. The next span turns from the assets to the cash tied up in running the business day to day.