ESMA guidance on Net Financial Position

published on 9 June 2024 | reading time approx. 4 minutes

The European Securities and Markets Authority ("ESMA") has published Guidelines ESMA32-382-1138 on disclosure requirements arising from EU Regulation 2017/1129. This document provides important guidance on the definition of Net Financial Position ("NFP") that may be of considerable relevance in the areas where this measure is used.

NFP is an indicator of financial performance and sustainability and, in general, can be defined as the sum of financial liabilities net of cash and cash equivalents and current financial assets.

NFP is widely used, first and foremost, in company valuations and M&A transactions, as the value of a target company is often determined using an 'asset side' approach, i.e. by first calculating the enterprise value from which the NFP is then subtracted to obtain the equity value. NFP is also applied in analyzing financial statements, in assessing business plans and in defining covenants in loan agreements.

Despite the importance of NFP, neither Italian nor international accounting standards provide a definition of it. For this reason, ESMA Guideline No. 39 (paragraphs 175 to 189), which is primarily addressed to listed companies, provides important advice that can be followed in the various areas of application.

In ESMA Guideline No. 39, NFP (defined as total financial indebtedness) is 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)

With regard to the items of the calculation, ESMA specifies as follows:

Other current financial assets should cover financial assets (for example securities held for trading) that are not cash, cash equivalent or derivatives used for hedging purposes.
Financial debt should cover debt which is remunerated (i.e. interest bearing debt) and which comprises, amongst others, financial liabilities related to short- and / or long-term leases.
Current financial debt should include debt instruments which are redeemable within 12 months.
Current portion of non-current financial debt means the portion of the non-current financial debt which must be repaid within 12 months.
Non-current trade and other payables should include non-remunerated debt for which there is a significant financing component, either implicit or explicit, for example debt to suppliers beyond a period of 12 months. Any non-interest bearing loans should also be included in this line item.
When assessing whether non-current trade payables have a significant financing component, a company should consider (by analogy) the guidance provided in paragraphs 59 to 62 of IFRS 15 Revenue from Contracts with Customers.

In the context of M&A transactions, adjustments are commonly made in determining NFP in order to adapt its value to the negotiating needs of the parties. Therefore, ad hoc adjustments agreed upon by the parties could be made to the above framework.

Lastly, with regard to the information that should be provided by the issuer, ESMA focuses on indirect and contingent indebtedness which is intended to provide investors with an overview of any material indebtedness that is not reflected in the statement of indebtedness.

Furthermore, indirect indebtedness also includes the maximum total amount payable in relation to any obligation which has been incurred by the issuer, but whose final amount is yet to be definitively assessed.

Examples of material indirect or contingent indebtedness include:

provisions recognized in the financial statements (such as provisions for pension liabilities or for onerous contracts);
a guarantee to honor a bank loan to an entity which is not in the issuer’s group, if this entity defaults on repayments on the loan;
a firm commitment to acquire or to build an asset in the next 12 months;
break-up fees or any compensation that must be paid by the issuer in the following 12 months if the issuer expects to fail any contractual commitments;
lease commitments which are not recognized as liabilities in the issuer’s financial statements and thus included in the statement of indebtedness;
amounts related to reverse factoring to the extent that such amounts are not already included in the statement of indebtedness.