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David asks:

Should EBITDA include non-operating income and expenses or not? I have received conflicting information regarding this.

Linda says:

Whether EBITDA should include non operating income and expenses for other types of analysis, I do not have an opinion. As a banker, for projected cash flow analysis, I would include it if you believe it to be recurring over the term of your loan. Heck, even for historical I’d include it because it explains how they could afford to pay their payments in the previous year. That non-operating income was part of the mix for debt payment capacity.

Example for projections

The company has excess office space and is renting it out to another company. If they have no expectations of needing it for their own operations within the time-frame of your loan and plan to continue to rent it out, I would suggest you include it.

If they are planning to expand into that space, do not include it for a recurring cash flow projection.

Do you care about GAAP or about debt repayment capacity?

I guess I am less concerned about the GAAP interpretation than I am getting our best, most reliable estimate of debt repayment capacity. If you are analyzing tax returns for debt repayment, which is most important to you?

Robert says:

Any income that is recurring and reliable should be used to support the debt, operating or not. When you get into larger loans, where the handshake of the guarantor doesn’t have that value it does on smaller notes, distinguishing operating capacity from other sources (i.e. non-operating income) can have merit when weighing risk.  

For smaller community bank style lending, I’d say anything recurring to support the payment is the customer’s effort to make good on their commitment and should be considered when looking at repayment capacity.

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Linda Keith, CPA

Linda Keith CPA is an expert in credit risk readiness and credit analysis. She trains banks and credit unions throughout the United States, both in-house and in open-enrollment sessions, on Tax Return and Financial Statement Analysis.
She is in the trenches with lenders, analysts and underwriters helping them say "yes" to good loans.
Creator of the Tax Return Analysis Virtual Classroom at www.LendersOnlineTraining.com, she speaks at banking associations on risk management, lending and director finance topics.