Page 45 - Bankruptcy and Reorganization Services

hand may be unusually low or high depending on the circumstances. Actual cash on hand for the subject
company is then added back to the value after the multiple is applied.

When deriving multiples, using the book value of debt from a company’s most recent financial state-
ments may not be an accurate proxy for debt when calculating the guideline companies’ MVIC in dis-
tressed situations. Under "normal" scenarios, a healthy company’s debt, if traded or recently issued, may
be close to par. However, companies (or industries) in distress may have debt trading significantly be-
low par value. Conversely, a healthy company’s debt may trade above par if market rates are above the
company’s cost of outstanding debt. Using the book value of debt as a proxy for market value can both
over- and understate MVIC under these circumstances. fn 6

Some multiples may be more appropriate than others for distressed companies, depending on the cir-
cumstances. Because companies in financial distress are frequently unprofitable, it can be difficult or
impossible to use certain earnings-based multiples. For example, multiples may need to be selected that
are less affected by certain expenses, such as interest expense. Furthermore, the use of an EBIT multiple
may not make sense if the subject company is experiencing operating losses. The analyst may have to
rely on multiples that are based on financial metrics other than earnings, such as revenue, gross profit, or
assets.

Because companies in financial distress typically have much higher levels of leverage than most compa-
nies, the analyst should also consider using MVIC multiples, which are less influenced by leverage than
MVE multiples.

Once the appropriate multiples have been selected, the analyst should select the appropriate time period
over which to measure the financial metric for the multiple. The two basic alternatives are (1) forward
looking (next fiscal year or forward twelve months) or (2) historical (latest fiscal year or trailing twelve
months). fn 7 The selection of the appropriate time period for the denominator will depend on the meas-
ure which best reflects the ongoing operations of the guideline companies and subject company. The
availability of financial information will also influence the selection. It is important to be consistent with
the financial metrics used for both the guideline companies and the subject company.

The financial metrics and associated multiple selected should reflect the operations of the subject com-
pany into the future. Using last twelve months (LTM) or last fiscal year (LFY) may not be an appropri-
ate earnings measure from which to derive multiples if the company being valued is expected to perform
substantially differently in the future than it did in the past. When valuing distressed companies, LTM
and LFY results may not be representative of the subject company’s restructuring efforts and potential
earnings capability going forward. As a result, a more appropriate time period to consider for normal-
ized earnings may be at the end of the next twelve months (NTM) or next fiscal year (NFY), in which
case the corresponding NTM and NFY multiples must also be calculated if the information is available.

fn 6 Use of the market value of debt in this context should not be confused with the need to use the face value of debt (plus the appro-
priate consideration of any contingent or unliquidated debt) in the context of a solvency study (see chapter 14, “Additional Reorgani-
zation Value and Plan Confirmation Valuation Issues,” of this practice aid).

fn 7 The period of time can refer to identical periods depending on the availability of financial data and the time periods under analy-
sis.

© 2020 Association of International Certified Professional Accountants 43