Most investors make extensive use of operating profit to assess company performance and as a starting point for valuation. But operating profit, like many company-provided subtotals, is not defined by IFRS; it is largely up to companies to decide what subtotals to include and even what to call them. However, the IASB may soon bring an end to this operating profit ‘free for all’. The proposal will lead to significant changes to the presentation of financial statements, notably the income s...| The Footnotes Analyst
Alternative performance measures (APMs) can be helpful for investors, but not necessarily the figure itself. It is the disaggregation of performance that is the real benefit. Focusing solely on adjusted measures means you will miss important aspects of profitability. We suggest how to use APMs to better understand performance, but without missing key elements. In our view this approach would provide a better basis for investor forecasts, as we demonstrate by disaggregating the IFRS earnings o...| The Footnotes Analyst
A change in accounting, such as the introduction of IFRS 16, does not in itself change underlying economics. It follows that equity values derived from DCF models should also be unchanged. However, the IFRS 16 lease accounting changes seem to be creating some confusion. We explain how to correctly adjust your DCF calculations and provide an interactive pre and post lease capitalisation model to illustrate. IFRS 16 makes DCF analysis easier and less prone to error; leaving your model based on ...| The Footnotes Analyst
You might assume that a change in enterprise value completely accrues to equity investors; however, this is often not the case. Other claims, such as debt or equity warrants also change in value as enterprise value changes. Understanding this effect can be important when analysing many companies, but especially those in financial distress. Option-like characteristics of debt and equity claims drive the allocation of changes in enterprise value between debt and equity investors. We apply an in...| The Footnotes Analyst
Losses caused by the rise in interest rates in 2022, coupled with inadequate interest rate risk management, appear to be the trigger for the collapse of Silicon Valley Bank. However, most of the losses on its fixed rate assets were not recognised in either the balance sheet or in profit and loss. We discuss why investors may have thought the bank was better hedged against interest rate risk than turned out to be the case, and show how 2022 profit would have been very different when measured o...| The Footnotes Analyst
The capitalised lease liability of an inflation-linked lease does not include expected inflation. This results in a lower liability and lower initial expense compared with an equivalent lease with no inflation link. The IFRS 16 figures are updated as the inflation uplift occurs, but these catch-up adjustments create a profit ‘headwind’. We estimate that Tesco’s inflation linked leases result in a pre-tax profit headwind of about 2.2 percentage points of growth. If inflation were include...| The Footnotes Analyst
DCF based values can be analysed between a current operating value and the value created by short-term growth, medium-term investment, and long-term franchise factors. We provide an interactive value analysis model and explain how this can help in understanding and refining DCF valuations, particularly if combined with adjustments in respect of intangible investment. DCF value analysis gives more insight than the common split between the present value of cash flows in an explicit forecast per...| The Footnotes Analyst
DCF valuation models can either be based on free cash flow attributable to equity investors or the free cash flow available for all providers of finance. Each requires a different approach to allowing for financial leverage, including adjustments to beta and recognition of the debt interest tax shield. We present an interactive DCF model that illustrates discounted equity cash flow and discounted enterprise cash flow using both the WACC and APV methods. Understanding each approach helps...| The Footnotes Analyst
The underlying rationale and conceptual basis for the equity method of accounting for investments in associates is unclear. Equity accounting can be regarded as either the cost-based measurement of an investment or as a quasi (one-line) form of consolidation – but neither is particularly helpful for investors. We explain the limitations of the equity method and advocate measuring all investments in associates at fair value, consistent with other minority equity holdings. This results in a m...| The Footnotes Analyst
