Skip to main content
diversification.com
← Back to A Definitions

Amortized ebitdar

What Is Amortized EBITDAR?

Amortized EBITDAR represents a financial metric that adjusts a company's Earnings Before Interest, Taxes, Depreciation, Amortization, and Rent (EBITDAR) by including an imputed interest component of operating lease payments. This metric falls under the broader category of Financial Metrics and is primarily used in financial analysis to provide a more comprehensive view of a company's operating performance, particularly for businesses with significant leasing activities. Amortized EBITDAR aims to normalize earnings by treating operating lease obligations more akin to traditional debt, thereby enhancing comparability across companies with different financing structures. The calculation of Amortized EBITDAR became particularly relevant following significant changes in Lease Accounting standards.

History and Origin

The concept of Amortized EBITDAR gained prominence largely in response to the evolution of lease accounting standards, specifically the introduction of ASC 842 by the Financial Accounting Standards Board (FASB) in the United States and IFRS 16 by the International Accounting Standards Board (IASB). Historically, many operating leases were treated as "off-balance sheet" financing, meaning the associated assets and liabilities were not fully recognized on a company's Balance Sheet. This obscured a company's true leverage and asset base.

The FASB issued FASB Accounting Standards Update 2016-02 in February 2016, effective for public companies in fiscal years beginning after December 15, 2018, and later for private companies8, 9, 10. This update, codified as Topic 842, fundamentally changed how companies account for leases, requiring lessees to recognize most leases on their balance sheets as a Right-of-Use Asset and a corresponding Lease Liability. This new standard aimed to increase transparency and comparability in Financial Statements7. Consequently, financial analysts sought ways to adjust traditional metrics like EBITDAR to reflect the impact of these on-balance sheet leases, leading to the development and increased use of Amortized EBITDAR. Officials at the Securities and Exchange Commission (SEC) have emphasized the importance of high-quality financial reporting and the challenges posed by new accounting standards, as discussed during discussions at the 2017 AICPA Conference on Current SEC and PCAOB Developments6.

Key Takeaways

  • Amortized EBITDAR adjusts traditional EBITDAR by incorporating an imputed interest component of operating lease payments, reflecting the impact of new lease accounting standards.
  • It provides a more accurate view of a company's operational profitability and its debt-like lease obligations, improving comparability.
  • The metric is particularly useful for industries with significant operating lease commitments, such as retail and airlines.
  • Amortized EBITDAR is a non-GAAP financial measure and requires careful reconciliation and disclosure.
  • It helps analysts and investors assess a company's ability to cover its fixed charges, including implicit lease interest.

Formula and Calculation

The calculation of Amortized EBITDAR typically starts with a company's reported EBITDAR and then subtracts an imputed interest expense related to operating leases.

The formula for Amortized EBITDAR can be expressed as:

Amortized EBITDAR=EBITDAR−Imputed Interest on Operating Leases\text{Amortized EBITDAR} = \text{EBITDAR} - \text{Imputed Interest on Operating Leases}

Where:

  • EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization, and Rent) is a commonly used operating metric that removes the effects of capital expenditures and financing decisions.
  • Imputed Interest on Operating Leases is the calculated interest expense that would have been recognized if the operating lease were treated as a finance lease, reflecting the time value of money on the lease liability. This often involves discounting future lease payments.

To calculate the imputed interest on operating leases, one would typically:

  1. Determine the present value of future operating lease payments, creating a hypothetical lease liability.
  2. Apply an appropriate discount rate (often the company's incremental borrowing rate or the implicit rate in the lease, if known) to this hypothetical liability to derive an interest expense for the period.

Interpreting the Amortized EBITDAR

Interpreting Amortized EBITDAR involves understanding its purpose: to provide a more holistic view of a company's operational profitability, especially for businesses with substantial leasing arrangements. By adjusting EBITDAR for the imputed interest on operating leases, analysts can better gauge the core earnings power of a company as if all lease obligations were recognized on the Balance Sheet as debt.

A higher Amortized EBITDAR, all else being equal, suggests stronger operational performance relative to the company's lease-related financing costs. It allows for a more "apples-to-apples" comparison between companies that own their assets and those that predominantly lease them through Operating Lease agreements. This is particularly crucial in industries like retail, where a significant portion of assets (e.g., store locations) are often leased rather than owned. Investors use this metric to assess a company's capacity to service its overall fixed obligations, including both traditional debt interest and the "debt-like" component of lease payments.

Hypothetical Example

Consider "Retailer X," a company that leases all its store locations. Before the new Lease Accounting standards, its leases were off-balance sheet. For a given fiscal year, Retailer X reports the following:

  • Net Income: $10 million
  • Interest Expense: $2 million
  • Tax Expense: $3 million
  • Depreciation: $4 million
  • Amortization: $1 million
  • Rent Expense (operating leases): $5 million

First, calculate the traditional EBITDAR:
EBITDAR = Net Income + Interest Expense + Tax Expense + Depreciation + Amortization + Rent Expense
EBITDAR = $10M + $2M + $3M + $4M + $1M + $5M = $25 million

Now, assume that under the new lease accounting standards, Retailer X's operating leases resulted in an imputed interest expense of $1.5 million for the year. This imputed interest represents the financing component of their Right-of-Use Asset and Lease Liability.

To calculate Amortized EBITDAR:
Amortized EBITDAR = EBITDAR - Imputed Interest on Operating Leases
Amortized EBITDAR = $25 million - $1.5 million = $23.5 million

This $23.5 million Amortized EBITDAR provides an analyst with a figure that more accurately reflects the company's operating performance if its lease obligations were fully treated as a form of financing, similar to traditional debt.

Practical Applications

Amortized EBITDAR finds practical application in several areas of financial analysis, particularly since the widespread adoption of new lease accounting standards. It is primarily utilized by analysts and investors to:

  • Improve Comparability: Companies with significant Operating Lease expenses, such as those in the retail, airline, or logistics sectors, can present distorted operational profitability when compared to companies that own similar assets or use Finance Lease arrangements. Amortized EBITDAR helps standardize this comparison by bringing the "debt-like" component of operating leases into consideration. This has been a particular challenge for retailers grappling with the new lease accounting rule5.
  • Credit Analysis: Lenders and credit rating agencies use Amortized EBITDAR to assess a company's capacity to cover its fixed charges, including both traditional interest and lease-related interest. This provides a more comprehensive view of a company's debt service capabilities and overall financial risk.
  • Valuation Models: In certain valuation methodologies, particularly those focusing on enterprise value, analysts may use Amortized EBITDAR as a proxy for operating Cash Flow before significant non-operating or financing effects, allowing for a more consistent multiple application across peers.
  • Internal Performance Management: Companies themselves may use Amortized EBITDAR as an internal performance metric to evaluate the operational efficiency of divisions or business units, especially those that extensively utilize leased assets.

Limitations and Criticisms

Despite its utility, Amortized EBITDAR, like many non-GAAP financial measures, has limitations and faces criticisms.

Firstly, as a Non-GAAP Financial Measures, its calculation is not standardized under Generally Accepted Accounting Principles (GAAP). This lack of standardization means that companies may calculate Amortized EBITDAR differently, potentially leading to inconsistencies and making cross-company comparisons challenging even with the adjustment3, 4. The Securities and Exchange Commission (SEC) actively monitors and comments on the use of non-GAAP measures, urging companies to avoid presenting misleading information and to provide clear reconciliations to GAAP figures1, 2.

Secondly, the "imputed interest" component itself requires estimation. Determining the appropriate discount rate for valuing lease liabilities can involve judgment, which introduces subjectivity into the calculation. This can make the Amortized EBITDAR figure less precise than reported GAAP metrics.

Furthermore, while Amortized EBITDAR aims to treat operating leases more like debt, it does not fully replicate the accounting treatment of a Finance Lease. A finance lease amortizes the right-of-use asset and recognizes interest expense separately, resulting in a front-loaded expense profile, whereas the operating lease expense recognized on the Income Statement under ASC 842 is typically straight-line over the lease term. Amortized EBITDAR attempts to isolate the interest component but doesn't alter the straight-line expense recognition for operating leases under GAAP.

Lastly, like its parent metric EBITDAR, Amortized EBITDAR still excludes actual cash interest payments, taxes, and capital expenditures (represented by depreciation and amortization), which are crucial for understanding a company's true financial health and sustainability. Relying solely on such adjusted earnings metrics without considering the full Cash Flow statement can lead to an incomplete financial assessment.

Amortized EBITDAR vs. EBITDAR

The primary distinction between Amortized EBITDAR and EBITDAR lies in how they account for the financing component of operating leases.

  • EBITDAR (Earnings Before Interest, Taxes, Depreciation, Amortization, and Rent) is a performance metric that adds back interest, taxes, depreciation, amortization, and rent expense to net income. Historically, "rent" primarily referred to operating lease payments that were expensed on the income statement but not capitalized on the balance sheet. EBITDAR's purpose is to approximate cash flow before these significant non-operating and non-cash items, making it useful for comparing companies with varying capital structures, particularly those with high lease expenses like retailers or airlines.

  • Amortized EBITDAR builds upon traditional EBITDAR by explicitly recognizing and adjusting for the imputed interest portion of operating lease payments. With the advent of ASC 842 and IFRS 16, which require most operating leases to be recognized on the balance sheet as a Lease Liability and a Right-of-Use Asset, the "rent expense" in EBITDAR now implicitly includes both principal and interest components. Amortized EBITDAR seeks to isolate and subtract this implicit interest component from EBITDAR, aiming to provide an earnings figure that more closely aligns with how finance leases (or traditional debt) affect profitability, offering a more precise look at operational performance by separating the "financing" aspect of leases.

The confusion between the two often arises because both metrics attempt to normalize for rent. However, Amortized EBITDAR offers a refinement by specifically adjusting for the debt-like interest embedded within operating lease payments as recognized under the newer Lease Accounting standards, providing a more granular view of a company's fixed charge coverage.

FAQs

What is the main purpose of Amortized EBITDAR?

The main purpose of Amortized EBITDAR is to provide a more standardized measure of operating performance for companies with significant leasing activities, especially after new lease accounting rules required most leases to be recognized on the balance sheet. It helps analysts compare companies that lease assets with those that own them.

Is Amortized EBITDAR a GAAP measure?

No, Amortized EBITDAR is a Non-GAAP Financial Measures. This means it is not calculated according to Generally Accepted Accounting Principles and companies may define and calculate it differently. Therefore, it should always be used with caution and accompanied by a reconciliation to the most comparable GAAP metric.

How do new lease accounting standards affect Amortized EBITDAR?

New lease accounting standards, such as ASC 842, require companies to recognize most Operating Lease agreements on their balance sheets as a Right-of-Use Asset and a corresponding Lease Liability. This change fundamentally altered how lease expenses are recognized in financial statements. Amortized EBITDAR adjusts for this by subtracting an imputed interest component from the overall rent expense, aiming to isolate the true operational profit before financing costs related to leases.

Which industries commonly use Amortized EBITDAR?

Industries that traditionally have high operating lease commitments, such as retail, airlines, hospitality, and transportation, often find Amortized EBITDAR particularly useful. These sectors frequently lease significant assets like stores, aircraft, or vehicles, making the metric valuable for comparing operational efficiency across competitors with different asset financing strategies.

What are the key components added back to net income to get to Amortized EBITDAR?

To arrive at Amortized EBITDAR, analysts typically start with net income and add back interest expense, tax expense, Depreciation, Amortization, and the full operating lease expense, and then subtract the imputed interest portion of the operating lease. This effectively attempts to isolate the core operating performance before non-cash charges and financing decisions.