EBITDA quality in a stagflation year: what a buyer sees that the owner doesn't

EBITDA is not wrong. It is incomplete, and a company that steers on an incomplete number ends up complete in the wrong direction.

Every owner of a mid-market company knows one number about the business by heart, and in nine cases out of ten it is EBITDA. The bank writes its covenants on it. The private equity fund that sent the unsolicited letter last spring multiplies it. The management bonus scheme pays out on it. When two owners meet at a sector dinner, it is the number they compare, usually without saying so.

There are good reasons for this. Earnings before interest, tax, depreciation and amortisation is the closest thing a P&L offers to an operating result that is comparable across companies with different financing, different tax positions and different accounting histories. It strips out the choices of the previous owner and the choices of the bank, and leaves something that looks like what the business itself produces. For a buyer comparing five targets, or a chair comparing this year with last, that comparability is worth a great deal.

The trouble starts when a number designed for comparison becomes a number used for steering. EBITDA was built to answer "how does this company compare?" It is now being asked to answer "is this company doing well?", and those are different questions. The second one cannot be answered by a figure that leaves out, by definition, four of the things that decide it.

What the number leaves out

Capital spending. EBITDA is calculated before depreciation, which means it is calculated as if the trucks, the machines, the software and the buildings were free. In a distribution or industrial business the fleet and the plant are the business; the depreciation line is not an accounting fiction but the slow invoice for assets that will have to be bought again. A company that defers replacement capex for two years will show a rising EBITDA and an ageing fleet, and only one of those shows up in the number.

Working capital. EBITDA is an accrual figure. It counts the invoice when it is sent, not when it is paid, and it counts the stock when it is sold, not when it was bought. A company that grows revenue by twenty per cent while its customers pay ten days later and its warehouse holds thirty days more stock can show record EBITDA and an overdraft that has doubled. The P&L applauds; the bank statement does not.

Interest. The metric is explicitly before interest, which was a harmless omission for a decade in which money was close to free. It is not harmless now. On 10 September the European Central Bank raised all three key rates by a quarter point and said inflation would remain well above target for an extended period. Every mid-market balance sheet with floating-rate debt, a revolving facility or a leasing book has just become more expensive to carry, and the one number the board watches most closely is constructed not to notice.

Tax. Before tax too, which matters less for steering and more for valuation: the cash that reaches the shareholder is after it, and in Belgium the route that cash takes has been repriced three times in a year.

None of this is news to a finance director. The point is not that EBITDA is a bad number. The point is that a company whose entire decision system – covenants, bonuses, board packs, the owner's own sense of how things are going – is calibrated to one number will systematically make the decisions that number rewards. Defer the capex, stretch the suppliers, carry the stock, take the floating rate. Each of these improves EBITDA this year and costs the company next year, and a steering system built on EBITDA alone cannot see the cost.

Why 2026 is the year the gap opens

In a stable year the gap between EBITDA and what a company actually generates is small enough to ignore. This is not a stable year. Belgium is running inflation of roughly four and a half per cent against growth of a fraction of a per cent, which is a mild stagflation read, and that combination flatters EBITDA in three specific ways.

Revenue inflates while volume slips. Price increases pushed through in 2025 and 2026 lift the top line. If the company is losing volume at the same time – and in most B2B sectors it is, quietly – the P&L shows growth and the warehouse shows decline. An EBITDA margin can hold or improve for four quarters on price alone while the underlying franchise shrinks. The number cannot distinguish a company that is winning from a company that is re-pricing its way down.

Indexation lands with a lag. Belgian wages follow inflation automatically, but not instantly. The cost base of the second half of 2026 is still partly priced on 2025 inflation; the 2027 cost base will carry 2026 inflation in full. A company that has pushed its prices through already and whose wage bill has not yet caught up is enjoying two or three quarters of margin that are borrowed from next year. The budget being built this month on the back of H2 2026 margins is being built on the top of that curve.

Capex and working capital absorb the shock first. When cash tightens, the first things a management team postpones are the fleet replacement and the warehouse upgrade, and the first lever they pull is supplier terms. Both decisions raise EBITDA. Both are invisible in it. A cash-tight 2026 produces, mechanically, a better-looking EBITDA than a cash-comfortable 2025, which is precisely backwards from the owner's point of view.

Put the three together and you get the pattern a chair should be watching for this winter: EBITDA up, free cash flow down, for several quarters in a row. It is the most common signature of a company that is about to discover its number was never the right number, and it will not show up in a board pack built around a single line.

What the buyer will do with your P&L

The reason to care about this now, rather than in a theoretical way, is that someone is going to do the work for you. Any sale, refinancing or minority investment in 2027 or 2028 will be preceded by a quality-of-earnings review of the 2026 accounts, and that review exists to answer one question: how much of the reported EBITDA would a rational buyer pay a multiple on?

The reviewer will decompose revenue growth into price, volume and mix, and will pay for volume. They will look at the year's price increases and ask how many customers were lost to them. They will normalise the owner's remuneration, the family members on payroll, the company cars and the rent paid to a related property company. They will look at customer concentration and apply a discount for every customer above ten per cent of revenue. They will compare EBITDA with operating cash flow for three years and ask why the two diverged. They will compare depreciation with capex and, if capex has been lower for two years, they will add the difference back as a cost. They will look at supplier days and, if the company has stretched them, treat the stretch as debt.

What survives this process is called adjusted or normalised EBITDA, and the distance between it and the number the owner quotes at dinner is, in my experience of the Belgian mid-market, the single largest hidden discount in a transaction. It is not a discount a buyer imposes; it is a discount that was always there, that nobody in the company had computed. A ten per cent gap between reported and defensible EBITDA on a seven-times multiple is seventy per cent of a year's earnings taken off the price, before any negotiation starts.

The owner who does this work first does not just protect a valuation. He gets a different company, because the exercise tells him which decisions of the last three years were real and which were borrowed.

The replacement: three numbers and one ratio

The answer is not to abandon EBITDA. It is the right comparison number and the bank will keep asking for it. The answer is to stop steering on it alone, which means putting three numbers in front of the board every quarter instead of one, and one ratio that exposes the gap between them.

EBITDA, as now, but with a price-volume-mix bridge attached to the revenue line. A board that cannot see how much of the year's growth was price has not seen the year.

Cash conversion, defined as free cash flow after capex and working capital as a percentage of EBITDA, on a rolling four quarters. In a healthy mid-market company this sits somewhere between sixty and ninety per cent depending on the sector and the investment cycle. The number itself matters less than its direction: a conversion ratio that falls for three consecutive quarters while EBITDA rises is the stagflation signature described above, and it is the single ratio most likely to tell a board something it did not know.

Return on capital employed, so that the EBITDA is seen against the capital that produced it. A company that grows EBITDA by ten per cent and capital employed by twenty has become a worse business while looking like a better one, and in a year when the cost of that capital has just gone up, that trade is more expensive than it was.

The ratio, cash conversion, does most of the work. It is the number a buyer computes first and the number most mid-market boards have never seen on one page. Tracked quarterly, it converts every one of the four omissions above into something visible: deferred capex lowers it, stretched suppliers lift it and then drop it, carried stock sinks it, and a floating-rate facility pushes the interest line through the free cash flow it measures.

Where the danger actually lives

A dashboard is the easy part. The hard part is what EBITDA has done to the incentive system, because that is where the number stops being a measurement and becomes a behaviour.

If the management bonus pays on EBITDA, management will defer the capex, because it is rational to do so. If the earn-out from the last acquisition is written on EBITDA, the integration will be run to protect the number rather than the business. If the bank covenant is on EBITDA alone, the finance director will manage to the covenant. None of these people is behaving badly. They are behaving as the number tells them to, and the owner who set the number has no grounds to complain about the behaviour.

The operator's discipline, then, is to decide what the company stops rewarding when it stops steering on EBITDA alone. The usual answer is to split the variable component – part on EBITDA, part on cash conversion, with a capex floor that must be met for either to pay – and to write the next earn-out on cash, not on earnings. That is not a sophisticated structure. It is the minimum structure that stops the metric from steering the company in a direction the owner did not choose.

What to do Monday morning

Three actions, none requiring a consultant.

Ask the finance director for one page: EBITDA, free cash flow after capex and working capital, and the ratio between them, for each of the last eight quarters. If the ratio has fallen for three quarters while EBITDA has risen, you have your winter's agenda.

Take the 2027 budget as it stands and ask two questions of it. How much of the revenue growth is price, and how much of the margin assumes the wage bill does not yet carry 2026 inflation? If nobody in the room can answer the second question in a sentence, the budget is being built on the top of the indexation curve.

Pull the last three years of capex against depreciation. If capex has been below depreciation for two of them, add the shortfall to this year's cost base in your own head, because the buyer will add it to theirs.

Then run the quality-of-earnings exercise on your own accounts, internally, before anyone else does. The buyer in 2028 will find the gap. The question is only who computes it first, and whether the company has two years to close it or two weeks to explain it.

EBITDA is the number everybody agrees on. That is a reason to report it. It was never a reason to steer by it.

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