Maintenance Capex: a Worked Example

EBITDA is struck before any charge for the wear on the equipment that produced it. That is a fair place to start and a poor place to stop, because the trucks, presses or chillers have to be replaced for the earnings to continue. A lender therefore asks how much of the year's cash is free after the assets have been kept whole, and treats that spending as ranking ahead of debt service in practice, whatever the loan documents say.

Unlike rent or interest, this cost can be postponed. Cut it for a year or three and the cash flow statement improves, the debt comes down and nothing appears to be wrong. Australian and international cash flow standards recognise the point: they encourage, but do not require, disclosure of the cash spent to maintain capacity separately from the cash spent to increase it, and explain that an entity under-investing in maintenance may be giving up future profit for present liquidity. Few private company accounts make that disclosure, in any of the three markets.

Each has a weakness. Depreciation is based on what the assets cost years ago, so in a period of rising prices it can understate replacement, and accounting lives may be longer or shorter than working lives. The capex-to-depreciation ratio is a quick test built on that proxy. The borrower's own split depends on labels: a replacement faster than its predecessor can be called expansion. The bottom-up route takes more work, because it needs an asset register with ages, but it is the one a lender can check. Where a project does both, the like-for-like cost is maintenance and only the excess is growth capex.

Two accounting edges matter. Routine servicing is an expense, while the cost of replacing a part can be capitalised if it meets the recognition tests, so a business that capitalises repairs lifts EBITDA and raises capex by the same amount. And assets replaced on hire purchase or lease may barely touch the capex line, since the cost comes through later as repayments. A lender deducts the replacement cost or the finance payments on those assets, and not both.

A rural contractor that cultivates, harvests silage and carts for farms, constructed for this page like every figure in it, runs twelve tractors, three forage harvesters and twenty implements. It earns EBITDA of US$3.2m, pays tax of US$0.4m and has debt service of US$1.6m a year. Depreciation is US$540,000. Capital spending has averaged US$300,000 a year for three years. Its asset register supplies the lives and current prices.

Nothing about the business has changed between the three lines. The first flatters it, by treating three light years as the normal level. The second is better but uses old prices. The third describes the fleet the contractor actually has to keep running. The US$1.45m is an estimate of replacement deferred and may be owed sooner than the cover ratios suggest. Then the request arrives: US$640,000 for a new forage harvester, described as expansion. It will replace one of the three, so the fleet stays the same size and, unless the new machine does more than the old one, all of it is maintenance. These levels and lives are the example's, not a market norm.

Growth capex can in principle be stopped without shrinking the business, and is often funded separately. Repairs and maintenance in the income statement are already inside EBITDA, so they need no further deduction. Depreciation is an accounting allocation of past spending, whereas maintenance capex is cash spent now. A lender's free cash flow is the place the figure ends up, and a capex covenant is a limit on spending in total, which can work against a lender if it stops needed replacement.

DEFINED IN ONE PARAGRAPH → · CAPEX TO DEPRECIATION → · GROWTH CAPEX →

It changes the debt a business appears able to carry, and it changes the tenor. A lender usually wants a term loan repaid while the asset is still working; if replacement is due in the third year of a seven-year loan, the cover ratio in year one is not the one that matters. In a sale or acquisition, a backlog of deferred replacement is a cost the buyer inherits, and a lender funding the purchase may adjust the price it is willing to support.

Asset-heavy businesses make this most visible. Issue 05 is a carrier whose fleet has aged while replacement was put off, so its request for new units has to be read partly as catching up. The logistics guide sets out how a desk reads a fleet. A borrower can help itself by offering the asset register and a replacement schedule before being asked: that is the evidence for a lower number, if a lower number is right.