JUNE 2015
CRITERIA
DBRS Criteria: Financial Ratio
Definitions and Accounting
Adjustments – Non-Financial
Companies
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
Contact Information
Paul Holman
Managing Director
Corporate Rating Committee
+1 416 597 7534
pholman@dbrs.com
Michael R. Rao, CFA
Managing Director,
Credit Policy
+1 416 597 7541
mrao@dbrs.com
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2
Table of Contents
Scope and Limitations
3
Financial Ratios and Definitions
3
DBRS Financial Ratio Adjustments
7
Off-Balance Sheet Items
8
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Corporate Finance
June 10, 2015
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
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Scope and Limitations
This criteria contains a list of financial ratios used by DBRS and includes a discussion of the common adjustments made to the accounting data to permit ratio comparability between issuers. The methods described herein may not be applicable in all cases; the
considerations outlined in DBRS methodologies are not exhaustive and the relative importance of any specific consideration can
vary by issuer. Further, this methodology is meant to provide guidance regarding the DBRS methods used in the sector and should
not be interpreted with formulaic inflexibility, but understood in the context of the dynamic environment in which it is intended to
be applied.
Financial Ratios and Definitions
Ratio definitions are followed by the definitions of the terms used in the ratios. Finally, discussion of the various accounting treatments and DBRS adjustments is presented. The ratios and financial statement adjustments discussed in this criteria are those generally applied by DBRS.
In the event that there is a material deviation from the standard calculation of ratios listed in this criteria, DBRS generally footnotes
the ratio’s revised definition in the applicable DBRS publication. While DBRS strives to provide as much clarity as possible to investors with respect to its ratio calculations, certain adjustments to its ratio calculations may be based on confidential information
provided by the issuer and the detailed amounts in these cases, therefore, cannot be disclosed publicly.
I. Ratio Definitions
1.
Gross margin = gross profit / revenue
2.
EBITDA margin = EBITDA / revenue
3.
EBIT margin = EBIT / revenue
4.
Net margin = core net income before minority interest / revenue
5.
EBITDA interest coverage = EBITDA / gross interest expense (assumes operating leases are not material)
6.
Lease-adjusted EBITDA interest coverage = EBITDA + operating lease expense /( gross interest expense + operating lease interest expense)
7.
EBIT interest coverage = EBIT / gross interest expense (assumes operating leases are not material)
8.
Lease-adjusted EBIT interest coverage = EBIT + operating lease interest expense / (gross interest expense + operating lease
interest expense)
9.
Fixed-charge coverage = EBIT + operating lease interest expense / (gross interest expense + operating lease interest expense + preferred dividends (adjusted using the statutory corporate income tax rate))
10.
DSCR for projects = (revenue - cash operating expense - income tax - maintenance capex) / (interest expense + principal amortization)
11
DSCR for utilities = (revenue - cash operating expense - cash taxes) / (interest expense + principal amortization)
12.
Debt / CFADS = total debt / EBITDA before taxes and after maintenance capex
13.
Debt / EBITDA = total debt / EBITDA (assumes operating leases are not material)
14.
Lease-adjusted debt / EBITDA = Lease-adjusted debt / Lease-adjusted EBITDAR
15.
Return on common equity = core net income after minority interest and preferred share dividends / average common equity
16
Cash return on common equity = (cash flow from operations – preferred share dividends)/ average common equity
17.
Return on capital = [EBIT x (1 - tax rate)] / average total capital
18
Cash return on capital = (cash flow from operations / average total capital
Corporate Finance
June 10, 2015
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
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I. Ratio Definitions
19.
Return on assets = [EBIT x (1-tax rate)] / average total assets
20
Cash return on assets = cash flow from operations / average total assets
21.
Debt / equity = total debt / total equity
22.
Debt / capital = total debt / total capital
23.
Lease-adjusted debt / capital = lease-adjusted debt / lease-adjusted capital
24.
Net debt / capital = (total debt - cash) / (total capital - cash)
25.
Asset coverage = (total assets - goodwill - future tax liability - deferred credits - minority interest - current liabilities + current portion of long-term debt +
short-term debt) / total debt.
26.
Asset turnover = total revenue / average total assets
27.
Current ratio = current assets / current liabilities
28
Current ratio, adjusted = non-monetary current assets / non-monetary current liabilities
29.
Current assets / total assets = current assets / total assets
30.
Accounts payable / inventory = accounts payable / inventory
31.
Quick ratio = (cash + receivables) / (total current liabilities)
32
Quick ratio, adjusted = (cash + receivables + inventory / (short-term debt)
33.
Inventory turnover days = 365 (average inventories / cost of goods sold)
34.
Receivable turnover days = 365 (average account receivables / revenues excluding)
35.
Payable turnover days = 365 (average accounts payable / cost of goods sold)
36.
Accumulated. depreciation / fixed assets = accumulated depreciation / gross fixed assets
37.
Cash flow / interest = (cash flow from operations + after-tax interest expense) / after-tax interest expense
38.
Cash flow / debt = cash flow from operations / total debt (assumes operating leases are not material)
39.
Lease-adjusted cash flow / debt = cash flow from operations + after-tax operating lease non-interest expense /
(total debt + capitalized operating leases)
40.
Cash flow / capex = cash flow from operations / capex
41.
(Cash flow – dividends) / capex = (cash flow from operations - preferred dividends - common dividends) / capex
42.
Depreciation / capex = depreciation / reported capex
43
Capex / depreciation, adjusted = reported capex / (depreciation + amortization +depletion)
44.
Common dividend payout ratio = common dividends / core net income less preferred dividends and minority interest
45.
Total dividend payout ratio = common and preferred dividends / core net income less minority interest
46.
Common dividend / cash flow = common dividends / cash flow from operations
47.
Distribution payout ratio = distribution / cash flow available for distribution
Corporate Finance
June 10, 2015
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
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II. Ratio Term Definitions1,2
1.
Amortization = reported amortization of goodwill & intangible assets
2.
Assets, total = reported current and long-term assets
3.
Assets, tangible = total assets - goodwill - intangible assets
4.
Capex = reported capital expenditures
5.
Capital, total = total debt + total preferred equity + total common equity + minority interest+ capital leases
6.
Capital leases = all non-operating leases
7.
Capital, adjusted = total capital + capitalized operating leases
8.
Cash = cash & cash equivalents + short-term investments
9.
Cash flow from operations = core net income + depreciation + amortization + deferred taxes + other non-cash items from income statement (before changes
in non-cash working capital items)
10.
Cash flow available for distribution = cash flow from operations - maintenance capex - leasing costs (before working capital)
11.
Cash flow, free = cash flow from operations - capex - dividends - change in non-cash working capital items
12.
Cash flow, free, before change in w/c = cash flow from operations - capex - dividends
13.
Cost of goods sold = costs incurred in production before depreciation
14.
Debt, total = short-term debt + long-term debt + hybrid debt portion + capital leases
15.
Debt, net = total debt - cash
16.
Debt, short-term = notes/short-term debt + current portion of long-term debt
17.
Debt, long-term = total debt - short-term debt
18.
Debt, lease-adjusted = total debt + capitalized operating leases
19.
Debt, hybrid = debt securities with equity-like features
20.
Depreciation = reported depreciation expense
21.
Depletion = reported amortization of value of resource property
22.
Dividends, common = reported common dividends
23.
Dividends, total = common dividends + preferred dividends + special dividends
24.
Distribution = amounts paid out to unit holders (usually from income trusts, REITs and MLPs)
25.
EBITDA = revenue - cost of goods sold - SG&A
26.
EBITDAR = EBITDA + operating lease expense
27.
EBITDA, cash = EBITDA excluding non-cash items
28.
EBIT = EBITDA - depreciation - amortization
29.
Equity, common = common shares + retained earrings + additional paid in capital
Corporate Finance
June 10, 2015
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
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II. Ratio Term Definitions1,2
30.
Equity, total = common equity + preferred equity + hybrid equity portion
31.
Gross profit = revenue - cost of goods sold
32.
Hybrids = debt hybrids + other securities with equity-like features
33.
Interest expense, gross = all interest expense + debt hybrid interest expense + capitalized interest (excludes any IFRS adjustments)
34.
Interest expense, net = gross interest expense - interest income from cash and short-term investments
35.
Interest income = interest and investment income
36.
Inventory = reported inventory including materials and finished product
37.
Lease adjusted debt = total debt + capitalized operating leases
38.
Leasing costs = tenant inducements, etc.
39.
Minority interest = ownership by others of consolidated subsidiaries (including common shares and preferred shares)
40.
Minority interest in earnings = minority interest in earnings of consolidated subsidiaries, joint ventures and
partnerships
41.
Net income, core = reported net income, adjusted to remove the impact of unusual items
42.
Net income, reported = reported net income
43.
Operating lease interest expense = operating lease expense ÷ 3
44.
Operating lease non-interest expense = operating lease expense * 2/3
45.
Operating lease expense (rent) = next period operating lease expense
46.
Operating lease, capitalized = operating lease expense * 6
47.
Receivables = reported receivables + notes receivable
48.
SG&A = selling, general and administrative expenses
49.
Tax, cash = actual cash income taxes remitted
50.
Tax, deferred = reported deferred income taxes, may be adjusted to remove the impact of unusual items
51.
Tax, income = cash and deferred income tax, adjusted to remove the impact of unusual items
52.
Tax, reported = reported income tax, before removing the impact of unusual items
53.
Unusual items = merger & restructuring charges + impairment of goodwill + gain (loss) on sale of assets &
investments + asset writedown + insurance & legal settlements
54.
Working capital = current assets - current liabilities
1. All numbers are typically annualized and normalized where applicable.
2. All ratios include the assets and income of any minority interests. Minority interests are included in total capital.
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June 10, 2015
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
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DBRS Financial Ratio Adjustments
DBRS adjusts financial information to permit better comparability between companies. The adjustments can be applicable across
industries (see below) or be industry-specific (see the respective DBRS methodology for applicable Primary FRR Metrics).
Asset values reported under Canadian or U.S generally accepted accounting principles (GAAP) are normally based on book values.
Asset values reported under International Financial Reporting Standards (IFRS) may be based on book or market values. DBRS may
show ratios both ways for a period of time (i.e., using market values and book values).
1. Interest Expense
In its calculation of interest- and fixed-charge coverage ratios, DBRS includes only interest expense directly attributed to indebtedness (including capitalized interest) in the ratio denominator. Any other expense/income items that have been included in interest
expense (e.g. amortization of issuance costs) are generally removed.
2. Income Statement Adjustments
Metrics can be distorted by items that may not meet the accounting definition of “extraordinary,” but are nevertheless one time and
considered unlikely to be repeated or are recurring and result in distortion of underlying economic reality. Unless these unusual
items are identified and removed, with tax adjustments if appropriate, then earnings and cash flow metrics and related ratios cannot
be considered as “core.” Care must be taken in any of the following adjustments:
a. There are cases where it would be incorrect to remove items in isolation (there may be corresponding related expenses or
revenues).
b. There are cases where certain costs may be ongoing and the one-time conclusion must be challenged (year-after-year reorganization costs is one example).
c. Unusual items should not be confused with volatile items. An entity may have a very unstable revenue source but it is still part
of its ongoing operations and should not be removed from core earnings simply because it is volatile.
d. Companies can default due to one-time costs. It may be reasonable to remove an entity’s major litigation settlement or reorganization costs to get a more accurate picture of core results, but one should not forget that whether it is a one-time cost or
otherwise, these expenses are still a cost that could cause a variety of challenges, including covenant triggers.
3. Cash Flow from Operations
Cash flow from operations as defined in Ratio Term Definitions (#9) may need to be adjusted as required (for example, for cash
items that are not captured by “core net income”).
4. Free Cash Flow
Free cash flow as defined in Ratio Term Definitions (#11) may need to be adjusted as required.
5. Equity Investments
Under many accounting standards, investments by one company in another are accounted for on a cost, equity or consolidated basis.
DBRS may adjust the reported statements if it believes that the resulting ratios would be more relevant and effective in depicting the
substantive effect of such investments on the entity’s credit profile (i.e. cost or equity investments may be consolidated, or consolidated entities may be proportionally consolidated or deconsolidated to an equity or cost basis.
In assessing equity investments, DBRS may consider a variety of factors, including some of the following:
a. What is the risk profile (business and financial) of the equity investment?
b. What is the ownership proportion (economic and voting)? Who are the other owners and what are the implications on
control?
c. How core is this investment to the company? Would the company invest more funds if needed? Are there other intercompany dealings between the two entities?
d. What is the dividend policy?
e. What is the fair market value of the investment and how liquid is it?
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June 10, 2015
DBRS Criteria: Financial Ratio Definitions and Accounting Adjustments – Non-Financial Companies
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6. Preferred Shares and Hybrid Securities
DBRS has a criteria that assesses the equity weighting for hybrid instruments. For more information, see DBRS Criteria: Preferred
Share and Hybrid Criteria for Corporate Issuers.
7. Pension Plans
In the case of defined benefit pension plans, DBRS does not typically include unfunded pension liabilities in any standard debt
metrics. Where material, however, DBRS may analyze these unfunded pension obligations separately as they add risk in terms of
future obligations and funding. DBRS recognizes that, point in time assessments of unfunded pension liabilities can be volatile as
underlying actuarial and economic factors (especially interest rates) change. Base considerations would include size of the plan and
the underfunded position relative to the size of the company and the flexibility the company has to deal with potential cash needs
and to return the plan to a more fully funded status. In some cases, other aspects of a plan (including the degree of conservatism in
key assumptions) may also be considerations.
Off-Balance Sheet Items
In addition to the aforementioned discussion on adjusting a company’s financial statements, there are a variety of ways that traditional debt-related ratios can be distorted by obligations that are not included in the base financial statements. The following
represents a checklist of items that DBRS would adjust for (if significant), along with a general description of how the adjustment
should be made.
1. Operating Leases
DBRS normally deals with operating leases by estimating the impact they would have on debt and interest costs if they were accounted for on the balance sheet. The method for adjusting debt ratios is to take the operating lease payment for the next one-year
period, multiply it by six and add it to debt (and thus it is also added to total capital). For coverage ratios, next year’s lease payment
is divided by three. This amount is then added to gross operating profit (since the full lease payment is assumed to have been paid
in operating expenses) and added to interest.
Where possible, the present value of the operating leases can be used in lieu of the estimate described in the paragraph above. The
present value is calculated using the minimum operating lease obligations, as recorded in the notes to the financial statements or
provided by the issuer. The capitalized amount of operating leases is normally added to on-balance sheet debt in this manner when
the amounts are material and represent financing for assets that are a core part of operations.
2. Guarantees and Contingent Liabilities
Generally, if an issuer has guaranteed debt of a separate entity (which debt has not been consolidated), the guaranteed debt should
be added to the issuer’s on-balance sheet debt for the purpose of calculating the issuer’s debt-related ratios. If the guaranteed entity
has more than adequate cash flow to service the guaranteed debt, however, DBRS may take this into account in evaluating debtrelated ratios of the issuer.
Contingent liabilities can be similar to guaranteed debt. However, by their nature, there is a much wider horizon of potential situations. In most cases, a contingent liability is not as meaningful as guaranteed debt because there are circumstances whereby the
company may be able to avoid the liability in question. There may also be other options for the company that reduce or avoid the
impact of the liability. DBRS assesses contingent liability on a case-by-case basis, considering the likelihood of any impact, as well
as the magnitude of the impact.
3. Securitizations
As DBRS views securitization as a form of debt financing, securitized assets of non-financial companies are normally added back to
debt to calculate adjusted debt ratios. (Note: In most cases IFRS requires securitized assets to be added back.)
Corporate Finance
June 10, 2015
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