A&S Rating. User manual. Creating synthetic credit ratings for intra-group financing

Transcription

1 User manual A&S Rating Creating synthetic credit ratings for intra-group financing Alder & Sound Oy Mannerheimintie 16 A Helsinki

2 Table of contents A&S Rating... 1 Table of contents... 2 Introduction Information on the data to be inserted and the resulting financial indicators The use of A&S Rating service Interpretation and further utilization of the reports obtained from the service... 9 Alder & Sound Oy

3 Introduction The A&S Rating service, developed by A&S, provides reliable basis for finding comparable, arm s length interest rates for intra-group financing purposes by creating synthetic credit rating for group companies. This user manual is intended to act as a first-hand guide in using the service and calculating the synthetic credit ratings. It also contains information on the data and indicators used in the calculations, as well as on interpretation of results and the methodologies and adjustments behind the results. Background Intra-group financing may offer multinational enterprises with alternative source for funding and opportunities to reduce the borrowing costs. Intra-group financing in transfer pricing context involves maximizing the tax effectiveness of intra-group financing transactions and increasing the firm s return on capital, while maintaining adequate compliance with international transfer pricing guidelines and local legislation. In order to arrive with arm s length interest rate to be used for intra-group financing purposes, there are two primary ways to perform the calculation: i) obtaining comparable information and benchmarking the interest rate separately for each of the financing and loan transactions; or ii) obtaining a rating from a credit rating agency. However, these approaches often either focus on individual transactions rather than companies (i.e. borrowers) and / or are heavy and impractical to use for transfer pricing purposes. The A&S Rating service, developed by A&S, provides reliable basis for finding comparable, arm s length interest rates by creating synthetic credit ratings for intra-group loan pricing purposes. In addition, the A&S Rating tool can be used for producing information for supporting the transfer pricing documentation and validation of executed intra-group financing and loan transactions. Synthetic credit rating Synthetic credit rating, by definition, refers to an internal credit rating assigned to a company based upon its financial ratios. The related analysis is performed by calculating the key financial ratios of the subject company (i.e. the intra-group borrower) and using comparable data from similar market ratings to assign a synthetic credit rating. The resulting rating can then be used to arrive with an arm s length interest rate for an intra-group loan. Compared to external credit ratings assigned by credit rating agencies, synthetic credit rating offers time and cost efficiency, especially when the amount of participating group companies is large, while maintaining high-level compliance and defendability. Structure of the A&S Rating user manual This user manual consists of three parts: Information on the data to be inserted and the resulting financial indicators; The use of A&S Rating service; and Interpretation and further utilization of the reports obtained from the service. We hope you find the using the A&S Rating tool effective and pleasant. Should you have any questions related to the service or the assigned credit ratings, please do not hesitate to contact us: Alder & Sound Oy Mannerheimintie 16 A Helsinki info@aldersound.fi Alder & Sound Oy

4 Legal disclaimer The A&S Rating service and reports contain information obtained from third party sources such as databases. Alder & Sound has used its experience and expertise to assess, as far as reasonably possible, the reliability and suitability of such third party data, and, if required, to perform adjustments in accordance with the generally accepted statistical methods. However, A&S cannot guarantee accuracy of the information or the adjustments made. No warranty for the information presented in this report is given by A&S. The information and the methodology used to produce the calculations and related report are protected under copyright. In addition, A&S retains all intellectual property rights in contents of this service, including layouts, design, methodologies, software and know-how. We also retain all copyright and other intellectual property rights in all reports produced through the A&S Rating service. The use of any reports or other material related to the service is limited within the user s organization. Should the user desire to make use of these materials outside the respective organization, this will require a written permission from Alder & Sound Oy. Alder & Sound Oy

5 1 Information on the data to be inserted and the resulting financial indicators This section provides information on the data to be inserted and the resulting financial indicators. It also includes detailed guidelines on how and in what form the company-specific data should be inserted to the input fields of the service. Information on the data to be inserted As mentioned in the introductory part of this manual, the synthetic credit rating refers to an internal credit rating assigned to a company based upon its financial ratios. The synthetic credit rating created through the A&S Rating service is based on a maximum of ten indicators that are calculated based on 13 different financials obtained from the subject company s income statement, balance sheet and cash flow statement. Below are presented short descriptions on the financial data and the figures to be inserted: Input value Description Assumed sign Income statement Net revenue EBITDA Depreciation EBITA Amortization Revenue is income that a company receives from its normal business activities, usually from the sale of goods and services to customers. Also referred as turnover or net sales. Earnings before Interest, Taxes, Depreciation and Amortization. All interest payments, tax, depreciation and amortization entries in the income statement are reversed out from the bottom-line net income / net profit. Cumulative amount of depreciation entries (related to tangible assets) deducted during the accounting period. Earnings before Interest, Taxes and Amortization. All interest payments, tax, and depreciation entries in the income statement are reversed out from the bottom-line net income / net profit. Cumulative amount of amortization entries (related to intangible assets) deducted during the accounting period. Only goodwill amortization should be included (amortization of e.g. software should be treated as depreciation). EBIT Earnings before Interest and Taxes. Interest expense Net profit Balance sheet Total amount of interest expenses paid by the company according to the latest financial report. Net profit is equal to the gross profit minus overheads minus interest payable plus/minus one off items for the accounting period. Average assets Average of assets for the two latest financial years. Total assets The sum of current and long-term assets owned by the company. Debt Total amount of outstanding debt according to the latest financial report. Cash flow statement Dividends Dividends paid according to the latest financial report. CAPEX Capital expenditures. Funds used by a company to acquire or upgrade physical assets such as property, industrial buildings or equipment Notes: - All values are to be inserted in relation to the assumed sign, e.g. expenses or other subtractive items do not require an additional minus sign, unless opposite to the assumption. Alder & Sound Oy

6 - When issuing new intra-group loan, the input values on interest expense and debt should reflect the post-transaction values (this might require utilizing iteration analysis to the interest expense). The sufficient number of indicators (and, thus, the financial figures) leading to a reliable synthetic credit rating assignment, as well as their relative reliability, varies from a company and industry to another. More information on the financial ratios and indicators is presented in the following paragraphs. Information on the financial indicators With regard to the financial indicators calculated based on the inserted financial data, there are few issues to be addressed. Book capitalization, as calculated for the synthetic credit rating report, refers to the balance sheet based book capitalization and equals total assets. FFO (funds from operations) refers to the sum of net profit, depreciation and amortization. Finally, RCF (retained cash flow) refers to the sum of net profit, depreciation and amortization reduced by dividends. As mentioned above, the reliability of the indicators varies from a year, company and industry to another. However, in general, the indicators can be considered as strong, moderate or weak indicators for determining the implied credit rating as follows: Data set & 2013 Strong indicators Moderate indicators EBITA / Average Assets EBITA / Interest Expense (FFO Interest Expense) / Interest Expense FFO / Debt Debt / EBITDA Debt / Book Capitalization EBITA Margin Operating Margin RCF / Net Debt EBITA / Average Assets EBITA / Interest Expense EBITA Margin Operating Margin (FFO Interest Expense) / Interest Expense FFO / Debt Debt / EBITDA Debt / Book Capitalization RCF / Net Debt Weak indicators CAPEX / Depreciation Expense CAPEX / Depreciation Expense Alder & Sound Oy

7 2 The use of A&S Rating service The profound idea behind the design of the unique A&S Rating service has been simplicity. As other approaches for assigning the credit ratings for group companies are often either focus on individual transactions rather than companies (i.e. borrowers) or are heavy and impractical to use for transfer pricing purposes, A&S Rating provides a simple but reliable basis for finding comparable, arm s length interest rates by creating synthetic credit rating for intra-group loan pricing purposes. The credit rating calculation process consists of three steps: 1. Selection of benchmarking data and input of relevant financial information. 2. Selection and calculation of relevant financial indicators. 3. Determination of company-specific synthetic credit rating and risk premium. Below each of the steps are briefly described through screen captures from the actual service. 1. Selection of benchmarking data and input of relevant financial information The front page of the service contains the benchmarking data selection and input fields for the company-specific financial information. The Data to be used -option is used to select the comparable data to be used. For benchmarking purposes, the most current data from the previous calendar year is generally also the most reliable. Notes: - The input values are not multiplier-specific, meaning that the values might be euros, thousands of euros, millions of euros etc. as long as the same scale is applied consistently to all input values. - The input values containing decimals should be inserted using a decimal point (American style) as the decimal separator (instead of a European-style decimal comma). Alder & Sound Oy

8 2. Selection and calculation of relevant financial indicators Based on the inserted data, ticks appear on the right side list indicating that the data is sufficient for the calculation of the marked indicator. Thus, none of the financial figures are mandatory but the synthetic credit rating is assigned based on the available information. As the reliability of the indicators varies from a company and industry to another, the A&S Rating tool allows you to select the indicators to which the calculation of the synthetic credit rating is based. Should you wish to exclude certain financial indicator from the calculation process, this is possible by simply unticking the box next to the unwanted indicator. With regard to the selection of appropriate financial indicators, our recommendation is that at least three (3) indicators should be utilized to arrive with a reliable credit rating calculation. The decision on the indicators to be utilized should be made based on their ability to reflect the true characteristics and financial situation of the subject company, taking into account issues related to income statement, balance sheet and cash flow information. Further guidance can be found from the typical indicators used in the industry where the subject company operates. Before making the final decision on the indicators to be utilized, one should also take into consideration the relative reliability of a particular indicator for determining the implied credit rating. For further information, please see page 6 (Information on the financial indicators). When the relevant financial data is in place and the appropriate indicators are selected, the calculation process can be initiated by pressing Calculate. 3. Determination of company-specific synthetic credit rating and risk premium. The A&S Rating report contains the following information: 1. Subject company name & report creation time 2. Synthetic credit rating assigned for the subject company 3. Risk premium (bps) based on the credit rating 4. Indicator-specific values and synthetic credit ratings 5. Legal disclaimer and restrictions for the use of report For the purpose of creating the synthetic credit rating for multiple group companies (or multiple ratings for a single company), the initial input form can be re-filled, after which the updated A&S Rating report is generated to a separate browser tab. A&S also offers tailored solutions and software for creating synthetic credit ratings for large-scale intragroup financing purposes. For more information, please contact us. Alder & Sound Oy

9 3 Interpretation and further utilization of the reports obtained from the service Interpretation of the A&S Rating report Besides the synthetic credit rating assigned to the subject company, the key output from the A&S Rating calculation is the interest margin spread reflecting the company-specific risk level. The spread is presented as basis points (bps), a unit equal to 1/100th of 1% (or 0.01%). In the process of calculating the final interest rate to be used for intra-group financing purposes, an appropriate reference interest rate is to be added with the benchmarked spread (risk premium). At this point, also other risk factors, such as the country or market area, are to be considered and taken into account, if applicable. Use of A&S Rating report as a part of transfer pricing documentation In addition to providing reliable basis for finding comparable, arm s length interest rates for intra-group loan pricing purposes, the A&S Rating tool and the reports obtained from the service can be used as a part of transfer pricing documentation and validation of executed intra-group financing and loan transactions. As the synthetic credit ratings per indicator presented in the A&S Rating report are formed by comparing the calculated values of the appropriate indicators to the aggregate median historical values of the corresponding metrics, the A&S Rating report serves as a CUP (Comparable Uncontrolled Price) analysis for intra-group financing and loan transactions. The second page of the report contains necessary information in order to establish an audit trail from the underlying benchmarking data to the results used for validation of the executed pricing. Alder & Sound Oy