What Does Financial Engineering Mean?
Financial engineering refers to the representation of financial information to present a higher level of earnings or EBITDA for a company that is for sale. Financial engineering can be performed by investment bankers, private equity groups or any other seller that is motivated to make the company for sale look more attractive and generate a potentially higher purchase price.
This definition of financial engineering in the context of buying or selling a business is different than the traditional investment banking term, which refers to the creation of a new financial instrument by combining existing ones, and then putting up the new instrument for sale to investors.
Divestopedia Explains Financial Engineering
Financial engineering is usually done by pushing recurring operating expenses below the EBITDA line, or classifying normal recurring expenses as non-recurring. Some examples of financial engineering include recording of operating leases as capital leases, adding back rental expenses to EBITDA under the assumption that a buyer would not rent equipment but buy it instead, or aggressively capitalizing repairs and maintenance so EBITDA is not affected.
The best antidote against financial engineering is the review of free cash flow rather than EBITDA. While EBITDA can be presented differently to suit the seller or buyer's needs, free cash flow is a number that cannot be changed with different accounting methods, and therefore is a better gage of a company's performance.