Yes, under modern accounting standards (IFRS 16 and ASC 842), operating leases are considered debt-like obligations and are included in the calculation of Enterprise Value (EV). They represent future contractual payments that act as debt, meaning they must be added to net debt—alongside finance leases—to accurately reflect a company’s total cost to acquire.
Operating Leases: We count them as “another investor group” here. The reason is that under IFRS, companies must split the rental expense into Interest and Depreciation elements on the Income Statement, so Operating Leases must be included in Enterprise Value – or multiples such as TEV / EBITDA will be inconsistent.
“An operating lease is different, as it is reflected as a lease obligation on the balance sheet and not reflected as debt,” Georgelas says.
Enterprise value can be expressed formulaically as the company's equity value plus its total net debt (being the company's long and short-term debt and debt like instruments minus its cash and cash equivalents).
Under IFRS 16, lease liabilities are recorded as debt, influencing several valuation elements: Net debt calculations should include lease liabilities to ensure EV is assessed appropriately.
Personal loan and credit card applications: Lease obligations are generally viewed as a form of debt by lenders, potentially impacting a consumer's approval and credit limits.
There are usually two types of debt, or liabilities, that a company accrues—financing and operating. The former is the result of actions undertaken to raise funding to grow the business, while the latter is the byproduct of obligations arising from normal business operations.
Enterprise value represents the total value of a company, including both equity and debt and excludes cash. EV represents the total expense involved in acquiring a business and offers a comprehensive view of the company's overall financial health and its capacity to generate cash flow to cover debt obligations.
Why do businesses add debt to enterprise value? Adding debt to enterprise value works on the same principle as deducting cash. Because EV serves as the cost to acquire a business, debt would be an added cost to the acquisition while cash would be deducted from that cost.
Understanding Net Debt
Breaking this down: Short-term debt includes obligations due within 12 months, such as bank loans coming due, accounts payable, and upcoming lease payments. Long-term debt covers obligations due beyond one year, like bonds, mortgages, and multiyear loans.
Operating lease accounting
Instead rentals under operating leases are charged to the statement of profit or loss on a straight-line basis over the term of the lease, any difference between amounts charged and amounts paid will be prepayments or accruals.
What is the 90% threshold for net present value for determining whether a lease is finance or operating? If the net present value of lease payments is greater than 90% of the fair market value, then it should be classified as a finance lease and not an operating lease.
Debt to Equity Ratio = Total Debt ÷ Total Equity
Where: Total Debt = interest-bearing short-term debt + long-term debt (include finance lease liabilities if material).
Under ASC 842, lease payments for operating leases are no longer expensed directly. Instead, the right-of-use (ROU) asset and lease liability are recorded on the balance sheet. As a result, EBITDA often increases because lease expense is removed, while depreciation and interest are excluded from EBITDA.
The lease term is greater than or equal to 75% of the asset's estimated useful life. The present value of the lease payments is greater than or equal to 90% of the fair value of the asset. Ownership of the asset may be transferred to the lessee at the end of the lease.
2) Also, when you calculate Enterprise Value, you'll have to include the Net Operating Losses as a Non-Operating Asset, typically by subtracting the NOL Balance * Tax Rate along with the other items you subtract in the calculation, such as Cash and Investments.
Enterprise value equals equity value plus net debt, where net debt is defined as debt and equivalents minus cash.
Formula and Calculation
Enterprise value is the sum of a company's market capitalization and any debts, minus cash or cash equivalents on hand.
Generally, a good debt ratio for a business is around 1 to 1.5. However, the debt-to-equity ratio can vary significantly based on the business's growth stage and industry sector. For example, newer and expanding companies often utilise debt to drive growth.
Debt-to-equity ratio formula
To use the D/E ratio formula, you'll need to understand what total liabilities are. Total liabilities includes: Short-term debt.
Enterprise value relates to the fair market value of the business prior to considering how that business is financed. It is determined through the consideration of pre-interest cash flows or earnings. As a result, it may be referred to as a “debt free” valuation conclusion.
While operating lease liabilities are not counted as debt under most loan agreements, they can still impact your leverage ratios and cash flow metrics, especially if lenders adjust for them in their models.
The liability associated with a Finance Lease is considered debt, which is consistent with previous Capital Lease treatment. For companies following IFRS, the new standard could cause some concerns over debt covenants as all leases will be Finance Leases and the lease liability will be considered debt.
The three main categories of debt are secured (backed by collateral like a house or car), unsecured (not backed by collateral, like credit cards or personal loans), and revolving (flexible credit, like credit cards), often contrasted with installment debt (fixed payments for a set term, like auto or student loans). These classifications help define risk, repayment structure, and lender rights, with secured loans being lower risk for lenders and unsecured higher risk, while revolving debt allows continuous borrowing up to a limit.