When Your EBITDA Lies to Your Banker

A client who runs a regional distribution business had $6.2M in revenue, 34% gross margins, and positive EBITDA every quarter for two years. His bank called in April to discuss covenant compliance. The trailing twelve months showed EBITDA of $310K, down from $520K the prior year.

He hadn't lost margin. Growth caused it. Two new customers required 90-day payment terms, so he built $380K of additional inventory to support them. Cash was sitting in receivables and stock. EBITDA captured none of it.

His bank's credit team saw compression and opened a covenant review. He spent three weeks producing documentation that should have been on file already.

Where EBITDA fails

EBITDA measures income, not cash. For a software business with minimal working capital, the two are close. For a product or services business with meaningful receivables, inventory, or project cycles, they diverge.

Growing businesses almost always see working capital expand before revenue does. Inventory builds ahead of orders. Receivables grow faster than collections when you're winning new enterprise accounts. Hiring runs ahead of billings. Each of these compresses EBITDA while the business is operationally healthy.

Underwriters adjust for this under normal conditions. They pull working capital schedules, receivables aging, and cash conversion data. In a tighter credit environment, those adjustments get made less consistently. Lenders default to EBITDA coverage against debt service because it's faster and easier to defend up the chain.

The businesses that lose credit access first aren't weak ones. They're businesses whose cash strength doesn't show up in the number lenders use under pressure.

What legible looks like

Legible, in banking terms, means a lender can evaluate your repayment capacity without asking for more data.

Three things make a working-capital-intensive business legible to a lender: a schedule showing receivables, payables, and inventory trends over at least six quarters; a cash conversion cycle calculation showing how long it takes a dollar of cost to become a dollar of collected cash; and a rolling cash flow forecast covering the next 90 days.

None of this requires new software. A good controller or fractional CFO can build it in a few days. Most companies don't maintain it until a bank asks for it. By then the conversation has already turned adversarial.

If your business has seasonal revenue, customers on 60-plus-day terms, inventory that turns slowly, or year-over-year growth above 20%, EBITDA understates your cash position. In a tighter credit market, that gap is what costs you the line.

Most companies build this documentation after they lose their credit facility. Build it before.