The CNDCEC Guidelines for the Calculation of EBITDA and NFP for Valuation and Transaction Purposes - Part 2

published on 11 June 2024 | reading time approx. 4 minutes

In professional practice and M&A transactions the definition of Net Financial Position (“NFP”) is often used as an alternative indicator of corporate performance and sustainability.

In a previous article, the notion of EBITDA was explained as the underlying element of business valuation. However, in this article the focus is the notion of NFP with reference to the research paper published on last 15 March by CNDCEC.

The first step in calculating NFP is to identify the relevant items of statutory financial statements. Firstly, the financial liabilities to be included are those related to financial liabilities on the balance sheet (“interest bearing debt”), like bonds, convertible bonds, shareholder loans, bank loans, and other lender loans.

In addition, other balance sheet liability items may also be included, provided that they are of a financial and non-trading nature (‘debt-like items’), for example: debt securities, debts to subsidiaries, associated companies, parent companies and companies subject to parent company control, and other debts. The nature of these items can be identified only by a case-by-case analysis with consequent inclusion in or exclusion from the NFP calculation.

What has always been the subject of some debate is, on the other hand, whether the severance package (“Trattamento Fine Rapporto – TFR”) has to be included in or excluded from the NFP calculation. According to an Italian view, the TFR would be considered as an item of current operations and, therefore, as such to be excluded from the NFP. On the contrary, as also sustained by the above-mentioned research document, it is preferable to adopt a more international approach, i.e., to consider the TFR in the NFP insofar as it can be equated to a financial debt, subject to periodic revaluation and therefore interest-bearing. The same considerations apply by analogy to the directors’ severance package (“Trattamento di Fine Mandato – TFM”) and, therefore, it too must be included in the NFP.

The second step in defining the NFP is to subtract cash and other cash equivalents from the debt position obtained. In Italian statutory financial statements, cash is under item ‘C) Current Assets IV. Cash and cash equivalents', while cash equivalents can be under items such as ’C) III. Financial assets not constituting fixed assets", more specifically “6) Other securities”. If these assets can be cashed in over a short period of time (such as short and medium/long-term government securities, postal bonds, certificates of deposit), they can be equated to cash.

Therefore, the NFP calculation can be summarized as follows:

Interest bearing debts + debt-like items + TFR and TFM - Cash and cash equivalents - Cash-like assets = Net Financial Position.

Internationally, with regard to International Financial Reporting Standards (‘IFRS’), following the adoption of IFRS 16 lease and rental debts also have to be included in financial debts since, due to the rule of substance over form, they de-facto entail cash outflows including implicit interest on a periodic and multi-year basis.

Moreover, the European Securities Market Authority (ESMA) provides principles for calculating the NFP. According to these principles, it can be calculated as follows:

A Cash
B Cash equivalents
C Other current financial assets
D Liquidity (A + B + C)
E Current financial debt (including debt instruments, but excluding current portion of non-current financial debt)
F Current portion of non-current financial debt
G Current financial indebtedness (E + F)
H Net current financial indebtedness (G - D)
I Non-current financial debt (excluding current portion and debt instruments)
J Debt instruments
K Non-current trade and other payables
L Non-current financial indebtedness (I + J + K)
M Total financial indebtedness (H + L)

As with EBITDA, in the context of M&A transactions, adjustments are commonly used in determining NFP in order to adapt its value to the negotiating needs of the parties. Some of these adjustments are:

Overdue current debts;
Unpaid payments of dividends already decided;
Non-interest-bearing intercompany payables;
Current year tax receivables and payables;
Missed inventory write-downs or bad debts;
Goods in transit;
Liabilities from financial derivatives valued mark to market;
Liabilities to suppliers for capital expenditure (“capex”);
Bonuses/incentives to management and employees already approved but not yet paid.

Lastly, in order to stabilize cash flows, many companies resort to factoring whereby a trade receivable is collected and its management delegated to a financial intermediary. In cases of pro-soluto factoring, all risks associated with the collection of the receivable are transferred. Inclusion of these items in NFP calculation has led to debates in the context of M&A transactions. There is as yet no settled position on this point, since in practice there are several possible solutions regarding the treatment of such items.