US GAAP vs. IFRS in Valuation and Financial Modeling (25:50)

Under both major accounting systems, the Income Statement and Balance Sheet are largely the same. Some items may have slightly different names, but the Income Statement still starts with Revenue, shows Expenses, and finishes with Net Income or After-Tax Profits.

The Balance Sheet still has Current and Non-Current Assets and Liabilities and an Equity section, and Assets = Liabilities + Equity.

The differences emerge mostly on the Cash Flow Statement. U.S. companies typically start with Net Income and adjust for non-cash items, but non-U.S. companies might start with Operating Income, Pre-Tax Income, or direct cash receipts and payments instead.

Items may also be in more random locations, such as Dividends appearing in Cash Flow from Operations.

Leases are also quite different because the Operating Lease Expense is split into Interest and Depreciation elements under IFRS, while it is just a simple Rental Expense on the Income Statement under U.S. GAAP.

To fix these issues, you need to find a reconciliation in the company’s filings that shows the bridge between Operating Income, Pre-Tax Income, or Net Income and Cash Flow from Operations.

You can then rearrange the Cash Flow Statement so that it starts with Net Income, adjusts for non-cash charges, includes the Change in Working Capital, and then proceeds to Cash Flow from Investing and Financing, neither of which should change much.

In terms of valuation multiples and the DCF analysis, Operating Lease Assets and Liabilities appear directly on the Balance Sheet under both accounting systems now, but the Income Statement and Cash Flow Statement presentations differ.

Under U.S. GAAP, if you count Operating Leases as a Debt-like item in Enterprise Value, you can no longer use EBIT and EBITDA because you must exclude the full Rental Expense in the denominator of valuation multiples.

So, the appropriate pairing is TEV Including Operating Leases / EBITDAR. Under IFRS, a metric like EBITDA already excludes the full Lease Expense, so it’s easiest to count Operating Leases as Debt in Enterprise Value and pair Enterprise Value with EBITDA directly.

When comparing U.S. and non-U.S. companies, stick to TEV Including Operating Leases / EBITDAR to make things as simple as possible.

In a DCF analysis, it’s easiest to deduct the full Lease Expense, which is easy under U.S. GAAP since there’s already a full deduction for it in Operating Income.

Under IFRS, it’s trickier because Operating Income (EBIT) deducts only the Depreciation element.

Therefore, you need to adjust by deducting the Interest element from EBIT, and then you multiply that by (1 – Tax Rate) to calculate NOPAT for use in the Unlevered FCF calculation.

When you add back D&A, you cannot add back the Depreciation element of the Lease Expense! So, you must review the filings and add back only the non-lease portions of Depreciation.

If the company does not disclose these, you could approach this process differently by adding back the Lease Depreciation in Operating Income to exclude the Lease Expense in EBIT and NOPAT completely.

You would then count the Operating Leases as a Debt-like item at the end of the analysis in the Implied Enterprise Value to Implied Equity Value bridge.

However, if you do this, some people might argue that you would also have to count Operating Leases in the WACC calculation, which is very subjective. Therefore, we prefer to deduct the full Lease Expense to avoid this problem.