A results release comes out and the headline carries a leverage ratio. Net debt over EBITDA, 1.9x for one company and 2.0x for another. The two figures sit side by side in the news and read as comparable.
I went through the latest reports of 15 listed companies. The net debt line is where I kept finding differences, and none of them is an error.
What accounting says
Net debt is not a line in the financial statements and it is not defined in IFRS. It is an alternative performance measure. The ESMA guidelines on those measures, in force since July 2016, ask the issuer to define it, to reconcile it to the financial statements and to keep the definition stable from one period to the next. They do not ask for the same definition across issuers.
Every company that follows the guidelines can publish a different number under the same label.
In the reports
A luxury group reports a net financial debt of 7 billion euro. The note says the figure leaves out lease liabilities and the commitments to buy out minority shareholders, mostly a put option written in favour of a partner on about a third of one of its businesses. On the balance sheet the leases are 16 billion euro and the commitments 6 billion euro. All the obligations together come to 29 billion euro, about 4 times the headline figure. All figures in this note are illustrative: rounded, and scaled on the proportions of the published reports.
Illustrative. Billion euro, rounded and scaled on published reports.
| Line item | Amount | Running | Multiple |
|---|---|---|---|
| Net financial debt as reported | 7 | 7 | 1.0x |
| Lease liabilities | 16 | 23 | 3.3x |
| Minority buy-out commitments | 6 | 29 | 4.1x |
| All obligations | 29 | 29 | 4.1x |
Illustrative case, rounded. Multiple is the running total divided by reported net debt.
The others differ in smaller ways. A spirits producer reports net borrowings and then an adjusted figure that adds post-employment liabilities, about 2 percent more. An information analytics group counts the fair value of its hedging derivatives in net debt and leaves pensions out, then puts pensions back in the ratio to EBITDA, which it calculates in dollars. A software company states its financial debt at nominal value, about 4 percent above the carrying amount. A stock exchange group excludes leases and the cash set aside for regulatory and operational purposes. A hearing aid manufacturer subtracts the loans it has made to its dispensers and restated the historical series to do it.
A hearing care retailer raised capital in May for an acquisition that had not closed by the end of June. At the reporting date the cash was on the balance sheet and the purchase was not. Net debt excluding leases was about 0.6 billion euro as reported and 1.05 billion euro pro forma, the figure the company publishes without the capital increase.
In the ratio
A leverage ratio takes one of these numerators and divides it by an EBITDA that has its own definition. When lease liabilities stay out of net debt while EBITDA is measured after IFRS 16, the two sides are on different bases: the lease cost has left EBITDA and the lease debt has not entered net debt. The ratio comes out lower than either consistent basis would give.
How to read it
The reading that works starts in the notes. The definition is there, with what is in and what is out. The figure is rebuilt on one basis, then the two companies are put side by side. It takes a few minutes per company and it is the step the headline ratio skips.
Read that way, the same ratios become usable. Read from the headline, they say how each company chose to count.
Open points
Where do lease liabilities belong when a retailer is compared with a software company: inside net debt, outside it, or on a line of their own?
Is a put option on a minority stake debt from the day it is written, or a contingent obligation that deserves its own line?
Which adjustment to net debt do you trust least in a results release, and which one would you never remove?