Mystery of Financial Expenses
It is agreeable by most people that interest expense is important for a corporation’s income statement. For geared private companies, the rate of servicing debt is a material cost.
The ultimate financial instrument standard would consist of 2 points; mark every instrument to market till the completion of the allotted time and bear the loss or gain through the revenue statement.
What is present today is a revised version of above paragraph that indicates that you should make it difficult for the handlers to comprehend what is happening through the P&L. It further says that the additional note should be complex and long so that nobody tries to read it.
In the financial expenses, there is only one important item that is buried within and that is the price of servicing debt. The capability of a corporation to maintain its clients and lenders satisfaction is of great importance. Yet, the interest protection is mostly impossible to estimate without any supplementary voluntary disclosure.
It is in fact a good idea to force companies into marking the financial tools to market. It eliminates subjectivity, reflects on reality, and reduces the possibility for financial engineering.
The issue here is that loss or gain is notional. When the tool is sold or is mature, that is what the ‘real gain’ is. By lumping together, the real-world expenses and the notional gains, you are creating a distorting and undesirable situation. To hedge out future currency cash flows, numerous derivatives are taken out. This reduces the real-world ambiguity but also increases the temporary reporting volatility.
Other than this, there are some other distortions as well. The pension interest expense might not be volatile; however, it differs from debt service expense. This is the notional cost of a projected long-term liability that has no allegations for cash flow.
Usually, the finance line includes the amortization of prearrangement fees. Furthermore, the price of early debt repayment is included in this as well.
Zero likenesses of reality
Nowadays, it is quite challenging to forecast financial expenses. The problem is usually of derivatives of mark to market, however, after the statistics get published, you cannot figure out what happened. A reason why the users focus on EBITDA and EBIT is that the financial items are no longer reflecting operating realism.
We now reside in a realm where interest rates are low and more private equity corporations have higher debts. Most of the latest failures of businesses are due to the increasing debt levels. Therefore, understanding interest expense is more important now than ever before.