Non-Operating Expenses

Profit and Loss Statement and Cash Flow Forecasting

When preparing the profit and loss statement and subsequently forecasting cash flows, we encounter expenses that are not directly related to operations, occur infrequently, and do not correlate with other line items.

Examples of such expenses include restructuring, goodwill write-offs, and major legal disputes.

Traditionally, these expenses are assigned to the past and ignored. However, it is logical to recognize that these expenses also have a predictable component. Therefore, for a qualified assessment, it is necessary to delve into the details. Here are some examples:

Amortization of Acquired Intangible Assets

The issue arises when an organization grows organically, as the capitalization of its intangible assets does not occur. However, during mergers and acquisitions, the capitalization and amortization of identifiable intangible assets are mandatory. We often need to compare organizations, and in such comparisons, it does not practically matter whether the growth was through acquisition or organically.

Moreover, a capitalized intangible asset (e.g., a trademark, customer lists) requires ongoing support through marketing expenses, which are already considered in the operating income. Therefore, adding amortization expenses again would result in double-counting. In contrast, for tangible assets, CapEx is not included in operating expenses, making depreciation logical.

Accordingly, the amortization of intangible assets should be approached as a non-operational expense, meaning NOPAT should be calculated from EBITA, not EBIT. In the reorganized balance sheet, the amortized portion should increase the intangible assets item, balanced by an equity equivalent item called “accumulated amortization.”

Note: Some intangible assets are more akin to tangible assets and should be treated as operational expenses. For example, a fixed-term cable television license does not require subsequent marketing support and is time-bound.

Write-Down of Tangible Assets

If the write-down of assets results from very rare events, it can be treated as non-operational and ignored. However, if it is repetitive and characteristic of the business, it will correlate with profit and loss or balance sheet items and should be forecasted accordingly.

Goodwill Write-Offs

Goodwill should be treated as a non-operational asset, and the reorganized accounts should be adjusted similarly to intangible assets.

Restructuring Expenses and Legal Disputes

It depends on whether these are rare events or characteristic of operations. For example, legal disputes are common occurrences for medical institutions.

Disposal of Amortized Assets

Gains or losses generated from the disposal of amortized assets are non-operational. It is important to identify which assets contribute to operational cash generation and how. A common mistake is forecasting both the revenue from the sale of an asset and the revenue generated by the asset itself. Additionally, it is often overlooked that forecasting the sale of an asset reduces amortization expenses.

Source:
#VALUATION – Measuring and Managing the Value of Companies, 7th Edition
McKinsey & Company,
Tim Koller, Marc Goedhart, David Wessels