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Improved Communication with

Non-GAAP Financial Measures

General Principles and Guidance for Reporting EBITDA and Free Cash Flow

A Canadian Performance Reporting Board Publication


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Library and Archives Canada Cataloguing in PublicationImproved communication with non-GAAP measures : generalprinciples and guidance or reporting EBITDA and ree cash fow.

ISBN-13-978-1-55385-397-8

1. Financial statements--Canada. 2. Accounting--Standards--Canada.3. Cash fow--Accounting--Standards--Canada. 4. Disclosure inaccounting--Canada. 5. Communication in accounting--Canada.I. Canadian Institute o Chartered Accountants

HF5681.B2I44 2008 657'.30971 C2008-901162-7


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Improved Communication with

Non-GAAP Financial Measures

General Principles and Guidance for Reporting EBITDA and Free Cash Flow


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PREFACE

Improved Communication with Non-GAAP Financial Measures General Principles andGuidance or Reporting EBIDA and Free Cash Flowis published by CICAs CanadianPerormance Reporting Board (CPRB). It contains general principles or reportingnon-GAAP nancial measures, and recommendations specically directed at reportingEarnings Beore Interest, axes, Depreciation, and Amortization, (EBIDA) andFree Cash Flow. Te guidance should be useul in reporting any non-GAAP measurein any type o entity, wherever the measure is publicly reported, or example inManagements Discussion and Analysis, earnings press releases, and the CEOs letter

in the annual report.

Non-GAAP nancial measures have become increasingly popular among preparersand investors who nd they provide additional insight into an entitys perormanceand nancial condition. Indeed, the popularity o such measures extends beyondnancial reporting and many nancial agreements contain conditions that aredetermined by reerence to a non-GAAP nancial measure.

While non-GAAP nancial measures are widely used, there are ew rules governing

their construction and disclosure. Tis leads to varied practices in reporting thesemeasures, even among entities competing in the same industry. More standardizationin their reporting, combined with more transparency in their disclosure, shouldimprove their comparability between entities and enhance nancial reportingcommunications. Tis is especially important in todays reporting environment whereanalysts reports are demanded immediately ater publication o an entitys results.Improved comparability and transparency should lead to more reliable non-GAAPnancial measures and a reduction in uncertainty or investors, and consequentlylower risk premiums in valuing investments.

While investors want more standardization in reporting non-GAAP nancialmeasures, management needs to be able to tell its story. Accordingly, any guidancethat advocates standardization needs to recognize that management must also be ableto communicate non-GAAP nancial measures that contain unique entity-specicmatters which management believes investors should consider.

Te general principles in this guidance discuss the characteristics o non-GAAPnancial measures. Four general characteristics are identied: the measures rely onhistorical inormation in their construction; the measures are drawn rom items

included in the nancial statements; the measures involve subjective judgementand estimates; and the measures are selective in the inormation they utilize. Tesecharacteristics are then reviewed in terms o their strengths and limitations. Tegeneral principles also discuss communications strategies or non-GAAP nancialmeasures that emphasize their strengths and complement their limitations.


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General Principles and Gidance for Reporting EBITDA and Free Cash Flow

Improed Commnication with Non-GAAP Financial Measres

Te guidance directed at reporting EBIDA and Free Cash Flow containsrecommendations that address three pieces o inormation that investors need.

Is the measure comparable between entities and consistent rom period to period?1.

For each o EBIDA and Free Cash Flow, the guidance recommends reportinga standardized measure that has a specied GAAP starting point and denedadjustments that are extracted directly rom the nancial statements. Accordingly,irrespective o the entity or the industry in which it operates, the standardizedEBIDA and Free Cash Flow measures should always contain the samecomponents and those components will have been constructed rom the rigorousGAAP ramework that applies to all entities.

How and why does the entity-specifc measure vary rom the standardized measure?2.

Entities oten want to communicate entity-specic inormation in a non-GAAPnancial measure. For example, management may wish to exclude a non-recurring expense rom EBIDA that is retained in the standardized calculation.Tey may believe that such a cost is not representative o operating costs on anongoing basis. Te guidance recognizes the need or such entity-specic measuresand recommends various disclosures that should accompany them. Te purposeor each entity-specic adjustment should be explained. As well, to acilitate anunderstanding o the dierences between the standardized and entity-specicmeasures, the entity-specic measure should be reconciled to the standardizedmeasure. Finally, any entity-specic adjustment should be related to the relevantitem in the nancial statements, so that the reader is able to identiy the amounto the item included in the nancial statements and the nancial statementcaption in which that item is presented.

What other inormation is necessary to understand the non-GAAP fnancial measure?3.

By their nature, most non-GAAP nancial measures use selective inormationrom the nancial statements. Accordingly, the guidance advocates additionaldisclosure to put the measure in context. For example, while StandardizedFree Cash Flow is an indicator o the entitys continuing capacity to generatediscretionary cash rom operations, the entitys other nancing and investingactivities compete with or complement Free Cash Flow. Tereore, the guidancerecommends additional disclosures that explain the relationship o the entitysStandardized Free Cash Flow to its other investing and nancing activities.

While this guidance ocuses on reporting EBIDA and Free Cash Flow, the CPRBbelieves that the general principles, entity-specic guidance, and complementarydisclosures should be helpul in deciding how to report any non-GAAP nancialmeasure. Tis material does not purport to deal with every issue encountered whenproviding disclosures about EBIDA and Free Cash Flow. Accordingly, uture


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Preface

releases may be necessary to address issues within these measures, or example inEBIDA, normalized earnings and issues rom Other Comprehensive Income, suchas oreign currency gains and losses rom translation o oreign subsidiaries. As well,uture releases may be needed as Canada moves to International Financial ReportingStandards.

Improved Communication with Non-GAAP Financial Measureswas developed by theBeyond-GAAP Measures ask Force o the CPRB. ask Force members are drawnrom the preparer, investor, academic, and auditor communities, and the developmentprocess involved consultation with preparers, investors, and securities regulators.Te CPRB would like to thank the Beyond-GAAP Measures ask Force or theirdedication in developing this material. Te CPRB would also like to thank all those

who provided advice to the ask Force during the materials development.

Tis guidance has taken into consideration comments received on an earlier dratthat was published in February, 2008. Te more signicant changes are set out in theappendix. Te CPRB plans to monitor application o this material and consult urtherwith preparers and users about any additional revisions. Tis guidance complementsearlier material that provided a ramework or reporting distributable cash in incometrusts and other ow-through entities. Te distributable cash material may, at someuture time, be incorporated into this document.

Te CPRB encourages comments on this guidance that should be sent to:

Chris Hicks, CA

Principal, Knowledge Development

Te Canadian Institute o Chartered Accountants

277 Wellington Street West

oronto

M5V 3H2

Or by e-mail to [email protected]

October, 2008
mailto:[email protected]:[email protected]


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TABLE OF CONTENTS

I. GENERAL PRINCIPLES

A. INTRODUCTION ..................................................................................7

Objective of non-GAAP nancial measures ........................................................................7

Nature of CPRB guidance ...........................................................................................................7

Importance of non-GAAP nancial measures .....................................................................7

Location of non-GAAP nancial measures and related disclosures ..........................8

B. THE OBJECTIVE OF CPRB RECOMMENDATIONS FOR

NON-GAAP FINANCIAL MEASURES ............................................8

Wide variety of practices in reporting non-GAAP nancial measures......................8

Responding to investors needs ...............................................................................................8

Improving comparability without sacricing informativeness .....................................8

C. THE CHARACTERISTICS OF NON-GAAP FINANCIAL

MEASURES .........................................................................................9

Historical information ...................................................................................................................9

Drawn from items included in the nancial statements ................................................10

Use of subjective judgements and estimates ...................................................................10

Selective information ................................................................................................................... 11

Distinguish between objective and entity-specic measures ..................................... 11

D. COMMUNICATIONS STRATEGIES THAT EMPHASIZE THE

STRENGTHS AND COMPLEMENT THE LIMITATIONS OF

NON-GAAP FINANCIAL MEASURES ........................................... 11

Standardized measures supplemented by entity-specic information .................. 12

Complement the measure with additional information ................................................ 12

Relationship of CPRB guidance to securities regulators requirements ................. 12

E. SUMMARY OBSERVATIONS ............................................................ 13

II. EBITDA

A. USES FOR EBITDA............................................................................ 15

EBITDA as a measure of operating performance ............................................................ 15EBITDA as a facilitator for valuation..................................................................................... 15

EBITDA as a proxy for cash ow ............................................................................................16


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II. EBITDA (CONTINuED)

B. ADJUSTMENTS MADE IN ARRIVING AT EBITDA ...................... 16

Cost of consuming capital assets ..........................................................................................16

Interest costs and taxes ............................................................................................................. 18

Non-recurring items .................................................................................................................... 18

C. DEFINITION AND DISCLOSURE OF EBITDA .............................. 18

A standardized denition of EBITDA ................................................................................... 18

Entity-specic EBITDA disclosures ....................................................................................... 19

D. CONTEXTUAL DISCLOSURES THAT

COMPLEMENT EBITDA ................................................................. 22

Capital assets ................................................................................................................................22

Financing strategy ...................................................................................................................... 23

Capital intensity and potential biases in EBITDA measures ....................................... 23

III. FREE CASH FLOW

A. USES OF FREE CASH FLOW ......................................................... 25

B. BASIS FOR CALCULATING FREE CASH FLOW ........................ 26

Free Cash Flow is a measure of cash generated from operations ...........................26

Free Cash Flow reects outlays for capital expenditures ...........................................26

Free Cash Flow does not address various

nancing and investing activities.......................................................................................... 26

Free Cash Flow includes nancing-type activities that are

characterized as operating activities .................................................................................. 27

Communication of Free Cash Flow ...................................................................................... 27

C. DEFINITION AND DISCLOSURE OF FREE CASH FLOW ........ 28

A standardized denition of Free Cash Flow ................................................................... 28Entity-specic Free Cash Flow disclosures ......................................................................30

D. CONTEXTUAL DISCLOSURES THAT

COMPLEMENT FREE CASH FLOW ............................................ 32

Relationship of Standardized Free Cash Flow to

investing and nancing activities.......................................................................................... 32

Relationship of the entitys capital expenditures to

its productive capacity strategy ...........................................................................................33

Financing-type activities that are characterized as

operating activities ..................................................................................................................... 24

APPENDIX

Signicant Changes To February 2008 Draft Guidance ............. 35


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I. GENERAL PRINCIPLES

A. INTRODuCTION

Objective of non-GAAP nancial measures

Non-GAAP nancial measures, such as Earnings Beore Interest, axes, Depreciation1and Amortization (EBIDA), Distributable Cash, and Free Cash Flow, are widely

used by both management and investors. Tey provide management and users withadditional analytical insight into an entitys perormance and nancial condition,expanding on the inormation provided by GAAP nancial statements.

Nature of CPRB guidance

Tis guidance provides general recommendations on the preparation and disclosureo non-GAAP nancial measures to assist preparers in eectively communicating andusers analyzing those measures. Tese general principles discuss the characteristicso the measures, and advocate the use o standardized and entity-specic measures

and disclosure o contextual and complementary inormation that can enhanceusers understanding o the measures. Te general principles were developed inconjunction with guidance or the specic non-GAAP nancial measures EBIDA,Free Cash Flow and Distributable Cash. Tese principles, however, together with therecommendations related to entity-specic measures and disclosure o contextual andcomplementary inormation, should provide useul guidance or reporting any non-GAAP nancial measure, including EBI and adjusted earnings per share.

Importance of non-GAAP nancial measures

Te importance o non-GAAP nancial measures is demonstrated by their use inmany contexts beyond nancial reporting to investors. Debt covenants may stipulatethat an entity shall maintain a dened EBIDA measure in excess o a specicamount (or in a ratio greater than a specic number). Executive compensation plansmay incorporate various measures o corporate perormance, including measures oEBIDA, to determine levels o compensation. Purchase and sale agreements ora business may stipulate either an initial purchase price or additional contingentconsideration based upon an EBIDA measure. Te incorporation o such measuresin private contracts supports the conclusion rom interviews with preparers andinvestors that such non-GAAP nancial measures provide incremental inormationvalue beyond that ound in GAAP inormation.

1 For nancial statement presentation and disclosure, many entities reer only to amortization, the termused in the CICA Handbookthat includes both depreciation and depletion.


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Location of non-GAAP nancial measures and related disclosures

Management decides whether to report non-GAAP nancial measures and related

disclosures in an entitys MD&A and other communications. Tis material hasbeen developed to assist preparers and users by oering presentation and disclosureguidance that preparers may use to improve comparability, consistency andtransparency o reporting and expedite users understanding o such measures. Whilethis guidance ocuses on reporting in MD&A, it is equally applicable in any publicdocument, or example a press release or the CEOs letter2.

B. THE OBjECTIvE OF CPRB RECOMMENDATIONS

FOR NON-GAAP FINANCIAL MEASuRES

Wide variety of practices in reporting non-GAAP nancial

measures

Prior to this guidance, there were no standard denitions o non-GAAP nancialmeasures. Tere have been a wide variety o practices observed in their reporting, evenamong entities competing in the same industry. For example, some companies excludenon-recurring items such as restructuring costs in an attempt to arrive at a normalized

amount while others do not. Despite such observations, non-GAAP nancialmeasures are inormative and their disclosure is oten driven in part by investors.Investors nd managements insights into the recurring and non-recurring nature oevents useul, and requently employ such classications themselves.

Responding to investors needs

Investors have indicated that it would improve the process o comparing andassessing perormance i there were standard denitions or these measures. Tis isparticularly important in the current environment where analysts reports are expectedimmediately ater management has published inormation. In addition, investors wantdisclosures that explain the reasons or entity-specic adjustments and how an entitysnon-GAAP nancial measures relate to its environment.

Improve comparability without sacricing informativeness

Te reorganization o non-GAAP nancial measures into standardized and non-standardized or entity-specic elements such as recurring and non-recurringcomponents should enhance the communication process without sacricing

inormativeness.

2 When the inormation is orward-looking, it should be accompanied by the disclosures specied by thesecurities regulators.


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General Principles

In addition, the inormation value o non-GAAP nancial measures is urtherenhanced by the presentation o a suite o complementary inormation in the samemanner that notes to nancial statements complement the GAAP numbers. Tisinormation should help the investor appreciate why management believes entity-specic adjustments are important to understanding the entitys perormance, howentity-specic adjustments are computed, and how they relate to items reported inthe nancial statements. As well, the complementary inormation provides context orunderstanding a measure and its limitations.

Te combination o improved comparability and increased transparency that theguidance advocates should lead to less uncertainty or investors. Tis should result ininvestors applying lower premiums in a valuation model. For example, investors have

told us that net debt to EBIDA is an important ratio in many circumstances, butone that does not receive the attention it deserves because investors oten have littlecondence in the EBIDA element o the ratio.

C. THE CHARACTERISTICS OF

NON-GAAP FINANCIAL MEASuRES

A consideration o the characteristics o non-GAAP nancial measures helps toidentiy the components that should be incorporated in a standardized measure andareas where additional contextual inormation should be provided. Four generalcharacteristics o most common non-GAAP nancial measures have been identied:rst, they generally rely on historical inormation; second, they are drawn romitems included in the nancial statements; third, they requently involve subjectivejudgements and estimates; and ourth, they provide selective inormation in anaccounting sense.

Historical informationInvestors generally seek inormation on the uture cash ows that they can expectrom their investments. Tis could be accommodated by entities publication oorecasted measures. However, the institutional ramework governing the presentationand disclosure o orward-looking nancial inormation in Canada, includingorecasts o nancial inormation, adds signicant responsibilities or issuers o suchinormation. In light o these responsibilities, and the related legal liabilities o theentity and its ofcers and directors, many issuers are reluctant to publish orward-looking nancial outlooks or statements.

Consequently, nancial inormation in an MD&A, including non-GAAP nancialmeasures, is oten restricted to historical inormation that acilitates the analysiso important trends and developments. I preparers present a non-GAAP nancialmeasure in their MD&A, there should be no requirement or the measure to use


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orward-looking inormation. It is expected that users o nancial statements will beable to orm their own orward-looking expectations by extrapolating trends evidentin the historical data, and using their judgement on how uture events will aectthose trends. Such extrapolations would undoubtedly be assisted by the provision ocontextual inormation that is pertinent to their cash ow orecasts.

Drawn from items included in the nancial statements

Non-GAAP nancial measures are drawn rom items included in the nancialstatements that are prepared in accordance with the rigorous ramework o GAAP,and where a reasonable degree o assurance is already provided by the auditor, at leastannually. Non-GAAP measures also inherit the limitations o the GAAP measures

rom which they are derived. Variations in GAAP accounting policies between entitiesin the same business can extend to non-GAAP nancial measures that incorporateamounts aected by such policies, leading to a lack o comparability in their respectiveEBIDAs.

Non-GAAP nancial measures usually cover the same time period as the relatednancial statements. In interim nancial reports, however, an entity may wishto disclose a measure on a trailing 12 month basis. When an entity makes such adetermination, the 12 month period should include the cumulative period addressed

by the related nancial statements and should explain why a trailing 12 month basisprovides meaningul inormation.

Use of subjective judgements and estimates

o provide eective communication, non-GAAP nancial measures should enablepreparers to convey their perspective on inormation that may not be evident rom theconstraints o GAAP-prepared nancial inormation. In some cases, such inormationwill convey managements judgement o the likelihood that an event will recur, e.g.,classiying a transaction or event as non-recurring.

Management may believe that such non-GAAP inormation provides valid insightsinto the entitys uture income stream or cash ows. On the other hand, the signalsconveyed by the non-GAAP inormation may in act be invalid, i.e. the managerialexpectations or characterization o the event may be mistaken. Non-recurringtransactions may in act recur, or the characterization o non-recurring may bebiased, ocusing only on the elimination o expenses and not providing an equivalentcharacterization o revenues.

A strength o non-GAAP nancial measures is that they add an additionalcharacterization o events not ound in the nancial statements. A limitation is thatthey may be based on subjective judgements and may be subject to bias. For suchmeasures to be inormative, an entity should be able to establish a credible basis ormaking such statements, apply it equally to all circumstances, and communicate thatcredibility to the user.


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General Principles

Selective information

Non-GAAP nancial measures either omit certain attributes o the GAAP measure

or add in amounts omitted in the nearest GAAP measure. For example, managementmay omit an item expensed in the periods nancial statements because it considersthat item to be not strategically relevant or not representative o the cost o itsreplacement. Tis characteristic can lead to non-GAAP numbers that are positivewhen the relevant GAAP number is negative, i.e. a loss. Te non-GAAP numbercan be used to generate inter-period comparative ratios such as percentage changesthat would not be meaningul i the negative GAAP number were to be used.Research indicates that EBIDA measures are more prevalent in rms that incurlosses measured in accordance with GAAP3. Te ability to acilitate comparisons

with positive numbers is undoubtedly a benet o such measures. Te limitation isthat the message embedded in the negative GAAP measure may be overlooked i itis relevant. An EBIDA measure, or example, may ail to indicate that an entity isunable to recover its initial investment in capital assets which may be relevant i theassets need to be replaced or the entity to continue in business.

Distinguish between objective and entity-specic measures

Te above-noted analysis indicates two types o characteristics related to non-GAAPnancial measures: those that are objective and drawn rom the nancial statements,

and those that are subjective and judgemental, related to the specic circumstances othe entity. Tese translate to two types o non-GAAP nancial measures: standardizedmeasures and entity-specic measures.

D. COMMuNICATIONS STRATEGIES THAT

EMPHASIzE THE STRENGTHS AND

COMPLEMENT THE LIMITATIONS OF

NON-GAAP FINANCIAL MEASuRES

Te general purpose o this guidance is to provide preparers with recommendationsthat will enhance the communication o the inormation in non-GAAP nancialmeasures. Tere are two types o Recommended Practices that should accomplish thisobjective: rst, the employment o standardized denitions in the disclosure o non-GAAP nancial measures with separate discussion o entity-specic adjustments; andsecond, the provision o inormation that complements such measures.

3 See Voluntary Disclosure o Free Cash Flow Inormation, A. Adhikari and A. Duru, AccountingHorizons(Vol. 20, No. 4 December 2006) pp. 311-332.


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Standardized measures supplemented by entity-specic

information

o provide a basis or improved consistency, comparability and transparency inreporting, the CPRB recommends that entities adopt a standardized calculation orreporting EBIDA, Distributable Cash and Free Cash Flow. Te guidance or thosemeasures provides elements to be included and excluded rom such standardizedcalculations. o convey inormation not ound in such a standardized measurethat management judges to be relevant to an entity, this guidance contemplatesAdjustments to standardized measures. Such adjusted amounts would be identiedseparately using appropriate terminology. Tis approach permits entities to conveyboth standardized and entity-specic inormation to investors.

Complement the measure with additional information

Non-GAAP nancial measures reect only selected aspects o GAAP. Accordingly,this guidance advocates disclosure o a suite o additional inormation to complementthe measure and enable the user to assess the implications o the measure. Forexample, the EBIDA measure excludes the eects o nancing and taxation, whichmay depend on the culture and history o the entity. o complement the EBIDAmeasure, investors could be inormed o the entitys nancing strategy and themanner in which the entity considers nancing matters in maximizing shareholder

value or creditor security. Similarly, non-GAAP nancial measures that ocus onliquidity, such as Distributable Cash and Free Cash Flow, could be complemented bydiscussions o the other investing and nancing transactions, and their signicance orunderstanding the entitys sources and uses o cash. Tese matters are more completelydiscussed in the recommendations addressing specic non-GAAP nancial measures.

Relationship of CPRB guidance to securities regulators

requirements

Securities regulations require various disclosures when issuers report non-GAAPnancial measures. Tese requirements include reconciliations o non-GAAP nancialmeasures to the most directly comparable GAAP number, disclosure o the purposeor the measure, and how the measure is used in managing the business4. Securitiesregulators also provide a denition or a non-recurring item.

Te CPRB hopes that this guidances additional specicity about components omeasures and expanded disclosures will complement the securities regulators materialand provide a ramework or disclosure.

4 CSA Sta Notice 52-306


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General Principles

E. SuMMARy OBSERvATIONS

Non-GAAP nancial measures are an important part o the nancial reportingprocess, and are useul in communicating inormation that complements andsupplements the nancial statements. Such measures have their strengths andlimitations. Tese recommendations address issues that have challenged users whohave been dealing with those limitations. Standardized denitions would improve thecommunication o the basic message. Entity-specic adjustments should be presentedater the standardized measure has been calculated. Contextual inormation thatcomplements the limitations o a specic non-GAAP nancial measure enhances theusers understanding o the measure. Using these principles, the CPRB is publishingrecommendations on selected specic measures in the belie that they will benetentities wishing to improve the communication process and users wishing to enhancetheir comprehension o an entitys perormance.

Te ollowing recommendations address specic matters that arise rom the use oEBIDA and Free Cash Flow. Tere is no nite universe o non-GAAP nancialmeasures: the initial recommendations ocus on the most commonly used measures.As previously noted, the CPRB believes that the general principles identied here canbe useully applied in most circumstances involving non-GAAP nancial measures,and encourages preparers and users to employ these general principles wherever

possible.


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II. EBITDA

Following the general principles set out in Section I, this guidance: (i) providesa standardized denition o EBIDA; (ii) encourages entity-specic EBIDAdisclosures; and, (iii) recommends contextual disclosures that complement EBIDA.

EBIDA is the most common non-GAAP nancial measure and is widely used byinvestors. Accordingly, the CPRB encourages entities to present EBIDA measures.Such inormation, presented in accordance with this guidance, should lead to moreeective and comparable communications.

A. uSES FOR EBITDA

EBITDA as a measure of operating performance

EBIDA is conventionally measured as net income beore discontinued operations,as reported in accordance with GAAP, plus interest expense, taxes, depreciation5,and amortization (all elements being as reported in the GAAP nancial statements).

Stated directly, EBIDA is the entitys revenue less its operating costs beore the costso consuming capital assets, nancing, and taxes. As such, EBIDA is a measure oincome, specically directed at an entitys operating perormance without the eectso its nance strategy or the recognition o certain costs or its tangible and intangiblecapital assets. EBIDA has application beyond nancial reporting and is oten theoperating perormance measure used in debt covenants and executive compensationplans.

EBITDA as a facilitator for valuation

EBIDA is requently used to acilitate an enterprise-level valuation o an entitythat is, a valuation o the entitys total assets excluding the eects o taxation andnancing6. For these purposes, EBIDA is multiplied by a actor or EBIDAmultiple that is based on observed or inerred relationships between EBIDA andmarket values to determine a rst approximation o Enterprise Value an entitystotal asset value without considering the value o the obligations it has assumed.Such estimates are then corroborated by other methods, such as discounted cash owanalysis or a valuation based on gross revenues. Te equity value o an entity is thendetermined using some assumptions about the magnitude and characteristics o debt

5 For nancial statement presentation and disclosure, many entities reer only to amortization, the termused in the CICA Handbook that includes both depreciation and depletion.

6 For an example o the discussion o the valuation o an entitys assets employing independent valua-tion, nancing and tax attributes, see M. Grinblatt and S. itman, Financial Markets and CorporateStrategy, McGraw Hill: 1998 pp 455 464.


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and other obligations. Tis valuation is then compared with other equity valuationtechniques, such as earnings per share models.

EBITDA as a proxy for cash ow

Occasionally, EBIDA is described as a proxy or cash ows rom operations7.Tere are some potentially signicant dierences, however, between EBIDA andcash ows rom operating activities, particularly as the latter is currently dened inNorth American GAAP. Even ignoring the cash costs o nancing activities and taxes,there is no recognition in EBIDA o the eects o changes in operating workingcapital balances. Tese may have signicant eects on cash ows when an entity isgrowing quickly, or in a seasonal business that involves variations in inventory levels.

I working capital balances uctuate signicantly, there will be material variationsbetween cash ow rom operating activities beore nancing costs and taxes and theEBIDA calculation.8

For these reasons, a direct cash measure such as the actual cash ows rom operatingactivities or a non-GAAP measure such as Free Cash Flow may be a more appropriateproxy or cash ow to be used in a valuation model. Both will vary as seasonal andother actors aect cash receipts and disbursements.

Despite these observations, it is likely that EBIDA will continue to be used as aproxy or steady-state estimates o operating cash ows. Its ease o computation andexclusion o signicant I and DA charges will undoubtedly contribute to itscontinued use or this purpose.

B. ADjuSTMENTS MADE IN ARRIvING AT EBITDA

In ormulating a denition or Standardized EBIDA and types o contextualinormation that will complement the measure, it is useul to consider theadjustments made in arriving at EBIDA.

Cost of consuming capital assets

By design, EBIDA does not recognize any expense or the consumption o capitalassets. Despite this limitation, management and investors still consider EBIDA arelevant perormance measure or several reasons:

7 See F.K. Reilly and K. C. Brown, Investment Analysis and Portolio Management, Tomson South-Western (2006) pp 304 307.8 Research has shown that there is a signicant correlation between EBIDA and operating cash ows

beore these provisions, but the correlation breaks down when changes in working capital are elimi-nated rom operating cash ows. See Foster, Financial Statement Analysis(2nd ed.) p. 80. When morerened adjustments to derive a cash ow measure are made, the resultant series is much less correlatedwith the original net income series.


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EBITDA

Amortization under GAAP is generally determined by reerence to a historicalcost measure (generally because this would not be true or newly acquired orrecently written down assets). In essence, income computed including this costmay indicate managements stewardship o their original investment, but maynot be indicative o the costs to replace that capacity, i it is so desired. Clearly,historical cost amortization does not provide users with inormation they wouldneed to estimate economic earnings or act as a proxy or uture cash outows tomaintain that capacity.9

Even assuming GAAP amortization measures are investor-relevant, theymay not be comparable between entities because o inconsistencies in thetreatment given to internally developed and externally acquired assets. wo

technologically identical entities with signicant intangible assets such as brandnames, innovative technologies, or customer contracts, may have very dierentamortization costs. One entity may capitalize and amortize intangibles becausethey arose as a result o acquisitions. Te other may have no amortization expenseas the intangibles are developed internally and are not capitalized. In these twoentities, the operating income ater amortization will not be comparable. Aterthe period o development or acquisition o intangible assets, however, theirrespective EBIDA should be comparable measures o operating perormance.

Ignoring tax consequences, the cost o past investment decisions (or the

amortization thereo ) is not a actor in determining the entitys uture cash owsor any group o assets.10 Once the decision has been made to invest in a plant,particularly one which is incapable o being used or any other purpose - suchas a mine -- its cost may not be relevant at all. Te only economic attribute ointerest would be the uture revenues rom its operation or sale. Its historical costsare irrelevant to decisions such as the rate o exploitation or sale or abandonment.Hence, a measure o returns such as EBIDA that excludes the historical cost ocapital assets may be very relevant to management and investors when evaluatingstrategic decisions.

Interest costs and taxes

By eliminating interest expense and, more generally, nancing charges and incometaxes, EBIDA presents a measure o the ability o an entitys assets to generateearnings separate rom managements decision to apply nancial leverage. EBIDAthus provides a basis or comparing entities perormance that is independent onancing arrangements and accordingly simplies comparisons between entitiesthat have dierent nancial structures. As a pre-tax measure, EBIDA is also ree

rom the eects o tax policies, the impact o which will be dependent in part on anentitys nancing strategy. Accordingly, to value an entitys equity rom a measure o

9 SEC Accounting Series Release 14210 Tis may not be true or rate regulated industries, or industries in which there is a normalized return

on assets.


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EBIDA, users must estimate the extent to which the entity will employ leverage andincur taxes.

Non-recurring items

Operating charges reported in accordance with GAAP oten include amounts thatmanagement may consider to be one-time or non-recurring, such as restructuring,gains and losses on investments, and other unique transactions. Managementrequently excludes such amounts rom EBIDA in an attempt to produce anEBIDA that represents normalized operating income. On the one hand,excluding non-recurring items rom EBIDA introduces the possibility o selectingonly unavourable transactions as non-recurring, substantially increasing the risk o

generating a measure that is biased and inconsistent. On the other hand, leaving non-recurring items in EBIDA provides more complete inormation about operationsthat, being specic to the entity, have a cost in reduced comparability. Analystsindicate that they do desire inormation about non-recurring items. However, analystsalso want to decide or themselves how to incorporate such items into their models.

C. DEFINITION AND DISCLOSuRE OF EBITDA

Users have indicated that a degree o standardization in the denition o EBIDA isdesirable or the measure to be comparable across entities. Managements, however, useEBIDA to communicate qualitative inormation about certain components o theearnings process the likelihood o persistence o specic expenditures, or example.Accordingly, a standardized approach to the communication o EBIDA needs toalso recognize managements desire to provide qualitative inormation. Tereore, theapproach should provide comparable elements, i.e. standardized elements, as well asenable the disclosure o entity-specic elements. o do this, the CPRB recommendsthat entities prepare EBIDA disclosures in accordance with the ollowing guidance.

A Standardized Denition of EBITDA

A standardized denition or EBIDA should reect the elements o EBIDA thatare drawn rom objective data. In particular, the CPRB believes that StandardizedEBIDA should reect EBIDA in its simplest orm E-B-I--D-A, where all theadjustments are items reported in the nancial statements. Te CPRB also believesthat Standardized EBIDA should be accompanied by a brie explanation o what themeasure represents.

Recommended Practice

A Standardized denition o EBIDA (in indirect orm) is:

net income or net loss beore discontinued operations as reported in the GAAP(i)


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EBITDA

nancial statements, including that net income or net loss related to any non-controlling interest, excluding amounts disclosed in arriving at net income ornet loss in accordance with GAAP or:

income taxes;i.

interest expense; andii.

amortization and impairment charges or capital assets.iii.

Te Standardized EBIDA calculation should be reconciled to net income or lossor the period determined in accordance with GAAP. It should also be accompaniedby the ollowing explanation o what the measure represents:

Standardized EBIDA represents an indication o the entitys capacity togenerate income rom operations beore taking into account managementsnancing decisions and costs o consuming tangible and intangible capitalassets, which vary according to their vintage, technological currency, andmanagements estimate o their useul lie. Accordingly, Standardized EBIDAcomprises revenues less operating costs beore interest expense, capital assetamortization and impairment charges, and income taxes.

o avoid conusion, a measure o EBIDA that varies rom the above-noteddenition should not be described as Standardized EBIDA.

Te standardized measure includes amounts related to any non-controlling interestas 100% o the assets o the consolidated subsidiary are included on the consolidatedbalance sheet (less inter-company accounts). Similarly, since investors use EBIDAto evaluate the continuing entity, this guidance excludes rom EBIDA the results odiscontinued operations that will not eature in uture earnings.

Entity-specic EBITDA disclosures

Management may wish to communicate entity-specic items that are not addressedin the standardized EBIDA denition. In that event, an entity-specic EBIDAshould be presented in addition to Standardized EBIDA. Te CPRB recommendsdistinguishing between the Standardized EBIDA measure and entity specicamounts because such a distinction promotes comparability while highlightingimportant entity-specic adjustments without requiring signicant work by the user.


Te CPRB recommends that when additional entity-specic adjustments are madein the computation o EBIDA:

these amounts should be separately disclosed ater the computation oi.Standardized EBIDA;

the adjusted amount should be reported as Adjusted EBIDA;ii.


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the purpose or each adjustment should be discussed;iii.

a reconciliation should separately disclose each adjustment betweeniv.Adjusted EBIDA and Standardized EBIDA;

or each adjustment, the corresponding item in the nancial statementsv.should be quantied; and,

the nancial statement component which contains the corresponding itemvi.should be identied.

Consistency in reporting entity-specifc amounts

Tese Recommended Practices should assist investors to quickly assimilate andunderstand the nature, amounts, and reasons or entity-specic adjustments. Tis is

acilitated when the nature o entity-specic adjustments is consistent rom periodto period, both with respect to the types o items adjusted and their computation.As well, adjustments should be consistent within the period. For example, when anadjustment is made or non-recurring costs, there should also be an adjustment orany non-recurring income. When a change is made to the components o the entity-specic measure, users understanding will be enhanced i the reason or the change isexplained and comparative amounts are presented in accordance with the new basis.

Considerations in determining entity-specifc adjustmentsMany entity-specic adjustments to Standardized EBIDA will likely reectincremental inormation about non-recurring expenses such as merger and acquisitionexpenses, restructuring costs and litigation settlements. Tere is no GAAP denitiono non-recurring. However, guidance on use o this term is provided by thesecurities regulators in CSA Sta Notice 52-306. Following that guidance shouldassist in ensuring that the same criteria are applied by all entities.

In addition to non-recurring items, the ollowing are examples o other matters thatentities have adjusted in arriving at an entity-specic measure:

Rent paymentsi. Under GAAP, capital leases are treated by the lessee as capitalassets that are depreciated over their useul lietime and by the lessor asdiscounted or interest-bearing obligations or rent. In the standardized calculationo EBIDA, amortization charges or assets acquired through capital leases wouldbe added back (under the indirect method). Similarly, the interest element o thecapital lease payment would also be added back. Operating leases, on the otherhand, are expensed, generally in a straight-line manner over the term o the lease.Tey are not added back when only amortization and interest are considered inthe computation o EBIDA.

Management may believe that both capital and operating lease contracts providesubstantively the same service. Te pro-orma capitalization o operating leasesby credit rating agencies in the determination o credit risk analysis may reinorcethis view. Management may thereore conclude that EBIDA should be


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EBITDA

measured ater adding back lease or rent payments or operating leases.

As noted, the denition o Standardized EBIDA does not contemplate the

adding back o rent payments on operating leases. Te treatment o operatinglease expenses as capital assets when calculating standardized EBIDA would bea challenging task in the current GAAP environment. Te re-characterization ooperating lease expenses as capital items would involve a signicant work eortthat may challenge preparers who commonly acquire items such as photocopiersand ofce premises under operating leases. Hence, the CPRB believes that theadd-back o operating lease payments or expenses should be considered only as anentity-specic adjustment.

Asset retirement obligationsii. Te calculation o Standardized EBIDA addsback amortization and hence eliminates the asset retirement obligation (ARO)expense related to the amount that is capitalized into the cost o assets. Unlike therelated capital assets, however, expenditure on AROs is not elective. Accordingly,management may conclude that such amounts should be addressed in an entity-specic adjustment. Alternatively, these obligations should be taken into accountin any discussion o an entitys nancing policies.

Post-employment benet under/over-undingiii. Te calculation o StandardizedEBIDA includes any amounts charged to expense that arise rom pension

accounting under GAAP. Te GAAP treatment o pension obligations and otherpost-retirement benets involves calculations that do not reerence the entitysactual cash contribution rate. An entitys unding may be more or less thanthe amount expensed in a year, which may involve amortization o actuarialgains and losses, ununded opening balances, and a variety o other non-cashitems. Signicant costs or benets may thereore exist that are not recognized inEBIDA (an issue that also exists in net income).

In a manner similar to the treatment o AROs, i under-unded or over-unded

pension obligations have not been reected in earnings, it is recommended thattheir impact be reected either through an entity-specic adjustment, or througha discussion o the nancing policies that should explain the policy or undingpension obligations.

Stock compensation expensesiv. Under GAAP, entities must reect incompensation expense the cost o stock-based compensation. Te method ocalculating that expense depends on the nature o the arrangement. In somecircumstances, stock-based compensation may involve signicant accruals oamounts that will not be settled in cash, but may be settled by the issuance o

shares in exchange. Share-linked settlements may result in the obligation beingsubject to signicant volatility as the price o the underlying shares uctuates.

Some managements add back stock compensation expense because they dontbelieve it should be considered in assessing perormance. We understand that


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some disagree with its accounting treatment because o its volatility. Othersdont believe it captures the true cost o the arrangement. Nonetheless, stock-based compensation is an operating expense that is accounted or in accordancewith GAAP. It reects part o the entitys compensation costs and is not relatedto nancing costs, taxes, or the consumption o capital assets. Accordingly,there does not appear to be a good argument or omitting such amounts romEBIDA. Tis is particularly true when comparability o measures is an objectiveo reporting EBIDA, or example when one entity compensates its managementwith cash measures while the other uses stock-based compensation.

When an entity adds back stock-based compensation in arriving at an entity-specic EBIDA, the CPRB believes that, in addition to discussing the purpose

or the adjustment, there should also be a discussion o the extent to which thetransaction has had a dilutive impact on the entitys equity.

Segmented EBIDA measures

Even when EBIDA is not the perormance measure determined by GAAP orsegment reporting, it would still be useul to disclose EBIDA by segment whenEBIDA is reported or the entity as a whole. In that case, it is suggested that boththe standardized and entity-specic measure be presented or each segment and thatthe entity-specic measure be applied consistently to each segment.

D. CONTEXTuAL DISCLOSuRES THAT

COMPLEMENT EBITDAAs discussed above, EBIDA has various strengths as a perormance measure. As well,used in isolation, it has limitations due to the exclusion o any measure o the costso consuming capital assets, and the costs o nance and taxation. Te CPRB believesthat the communication o EBIDA inormation should include disclosure that

complements the measure by providing investors additional inormation about thesematters so that EBIDA can be placed in context.


o enhance the communication o EBIDA, entities should complementStandardized EBIDA with additional disclosures about the specic circumstanceso the entitys capital assets and nance strategy.

Capital assets

EBIDA does not recognize any costs or the consumption or replacement ocapital assets even though such costs exist in most entities that are going concerns.Accordingly, there should be some discussion o the entitys productive capacity,


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III. FREE CASH FLOW

Following the general principles set out in Section I, this guidance: (i) provides astandardized denition o Free Cash Flow; (ii) encourages entity-specic Free CashFlow disclosures; and, (iii) recommends contextual disclosures that complement FreeCash Flow.

Free Cash Flow is a measure that is becoming increasingly popular with investors.Accordingly, the CPRB encourages entities to present Free Cash Flow measures. Suchinormation, presented in accordance with this guidance, should lead to more eective

and comparable communications.

A. uSES OF FREE CASH FLOW

Te cash ows o an entity can be analyzed in a variety o ashions. Te GAAP cashow statement classies them by operating, nancing, and investing categories. Otheraggregations o cash ow are used by preparers and investors in analyzing the periodicamounts o cash generated and consumed by an entity. Tese involve combining the

operating activities with some elements o the nancing and investing activities inorder to provide a measure o the internally generated cash ow available or debtrepayment, internal growth, or distributions to shareholders.

Many entities report one such measure, Free Cash Flow, as an indicator o nancialstrength and perormance. Free Cash Flow measures the amount o cash romoperating activities net o capital expenditures (capex) available or activities suchas repayment o debt, distributions to owners, and investments in uture growththrough acquisitions. Te primary objective o Free Cash Flow is to assist users in

projecting uture cash ows or valuation purposes, but the measure may also assist indetermining an entitys ability to maintain liquidity and operations or the oreseeableuture.

Given the lack o a generally accepted denition, there are many dierent calculationso Free Cash Flow used by preparers. Te CPRB believes that more eective andefcient communication o this inormation would be accomplished by some degreeo standardization in the denition o Free Cash Flow. Likewise, distinguishing anddiscussing the components o an entity-specic denition rom the standardizeddenition would enhance the efciency and eectiveness o the communication.


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B. BASIS FOR CALCuLATING FREE CASH FLOW

Free Cash Flow is a measure of cash generated from operations

A strength o Free Cash Flow measures is that they ocus on cash ows (hence thelabel) and thereby avoid some o the complexities o earnings measures allocationsand accruals. Te measure is based on an entitys ability to generate operating cash.Accordingly, most denitions o Free Cash Flow employ cash ows rom operatingactivities as the starting point or the calculation.

As a measure based on operating cash ows, many entities Free Cash Flow reectsthe cash provided rom or used in changes in working capital, consistent with the

GAAP measure cash ows rom operating activities. Some entities, however, excludesuch changes in working capital rom their measure o Free Cash Flow because theyview these changes as timing dierences under managements control that obscure theunderlying cash ow trends.

Free Cash Flow reects outlays for capital expenditures

In a going concern, expenditure on capital assets is clearly one o the most signicantuses o operating cash, as the entity reinvests in capital assets in order to maximize

shareholder wealth. Te net amount o operating cash ows and capital expendituresprovides an indication o the entitys need or external nancing. For a protable yetgrowing rm, or example, capital expenditures may exceed cash rom operations,resulting in a need or additional cash despite protability. On the other hand, amarginally protable entity may only require minimal spending on replacementcapacity. Such a rm may have the ability to distribute cash rom operations by payingdown debt, or making distributions in the orm o dividends or share repurchases.Tese are the signals, distinct rom protability, that are eectively communicated bya Free Cash Flow measure.

Free Cash Flow does not address various nancing and

investing activities

Free Cash Flows strength as a measure ocuses on operating cash ows. Tis ocusis also a limitation in that it is a selective measure o an entitys cash ows. Anunderstanding o an entitys cash ow is incomplete without insights into its othernancing and investing activities.

Generally, Free Cash Flow measures do not reect nancing activities such as paying

dividends and renancing debt implying that these are discretionary uses o the reecash. Some o these activities may be non-discretionary, however, or example payingdebt on its maturity in the absence o rollover or renancing provisions. I Free CashFlow measures are to be used eectively, the user needs to be able to distinguish suchactivities rom those that are in act at the discretion o management.


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Free Cash Flow

As well, Free Cash Flow normally does not include cash expended or received onaccount o acquisitions or disposition o discontinued operations. M&A activityin particular may represent an alternative to capital expenditures using cash or themaintenance or growth o productive capacity.

Accordingly, Free Cash Flow should not be viewed in isolation, but rather inconjunction with contextual disclosure that discusses an entitys other nancing andinvesting activities.

Free Cash Flow includes nancing-type activities that

are characterized as operating activities

While Free Cash Flow measures do not generally include the nancing activities thatare presented in the cash ow statement, there are various nancing-type transactionsthat are characterized by GAAP as operating activities and consequently included inthe denition o Free Cash Flow when paid or received. Tese activities can eitheraccelerate or deer the cash ow related to the transaction in question. Consider,or example, the cash ows associated with an enhancement o prior period servicebenets as part o a labour agreement. A cash ow may occur shortly ater theinitiating transaction, or it may not occur or several years.

Other nance-like transactions that aect operating cash ows involve varying degreeso management discretion. For example, cash ows or a period may be enhanced by asecuritization o receivables, which is essentially a short-term acceleration o cash owsresulting rom an activity almost completely at managements discretion.

When nancing-type activities exist that are characterized as operating activities underGAAP, it may be difcult to determine the nature o the source o such ree cashwithout additional disclosure or analysis.

Communication of Free Cash FlowTe communication o Free Cash Flow should emphasize its ability to indicate whena highly protable entity is in need o nance, such as when it is in growth mode. Itshould also be able to indicate the opposite condition - a marginally protable entitythat has excess cash because o minimal capital expenditure requirements. Eectivecommunication should also recognize that, in isolation, the measure has limitations.For example, it does not reect other cash transactions and M&A activities.11Neither does it present a picture o discretionary cash when other claims such as debtrepayment are compelling. Accordingly, other disclosures need to complement the

Free Cash Flow measure so that a suite o inormation is presented, such as the natureand extent o other sources, and the total other uses o cash. When Free Cash Flow

11 It has been noted that entities that suspend share buy-back programs are oten stockpiling cash to usein acquisitions.


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is negative, the discussion should consider the sources o cash (i any) that oset thenegative Free Cash Flow. When Free Cash Flow is positive, the discussion shouldaddress how that cash is being used.

C. DEFINITION AND DISCLOSuRE OF

FREE CASH FLOWFormulating a denition o Free Cash Flow that standardizes its calculation andthereby enables comparisons necessarily involves making some judgements andchoices. Te CPRB recommends that Standardized Free Cash Flow reect cash owsrom operating activities less capital expenditures net o proceeds o dispositions

other than those related to discontinued operations, with no deduction o dividendpayments unless the dividend is stipulated, and with no exclusions or changes inworking capital. o acilitate its understanding, the CPRB believes that StandardizedFree Cash Flow should be accompanied by a brie explanation o what the measurerepresents.

Tis denition o Free Cash Flow will not necessarily result in a measurethat represents the net cash generated in the period that is available or use atmanagements discretion. Rather, as cash rom operating activities net o capital

expenditures and those dividends that are more representative o interest costs, themeasure should be an indicator o the entitys capacity to generate discretionarycash rom operations. Other sources o cash, or example proceeds rom raising newcapital or selling discontinued operations, will generally not be a continuous sourceo cash. Te notion that Free Cash Flow is ree may be incorrect. Tere may belittle discretion in some o the entitys other cash transactions, or example paymentsrequired under debt agreements. In these circumstances, however, in a going concern,it would generally be expected that the debt repayment would be matched with theentitys ability to obtain new debt nancing. In circumstances when management

believes that a transaction not contemplated in the denition o Standardized FreeCash Flow is compulsory and does not result in a corresponding access to additionalcash resources, that transaction can be highlighted in the analysis o investing andnancing activities (see below) or reected in an entity-specic measure.

A Standardized Denition of Free Cash Flow


A standardized denition o Free Cash Flow is:

Cash ows rom operating activities as reported in the GAAP nancial statements,including operating cash ows provided rom or used in discontinued operations;less:


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Free Cash Flow

total capital expenditures minus proceeds rom the disposition o capital assetsi.other than those o discontinued operations, as reported in the GAAP nancialstatements; and

dividends, when stipulated, unless deducted in arriving at cash ows romii.operating activities.

Te Standardized Free Cash Flow calculation should be reconciled to cash owsrom operating activities or the period determined in accordance with GAAP,disclosing separately each adjustment to cash ows rom operating activities,including proceeds rom the disposition o capital assets. It should also beaccompanied by the ollowing explanation o what the measure represents:

Standardized Free Cash Flow represents an indication o the entitys capacityto generate discretionary cash rom operations, comprising cash ows romoperating activities less net capital expenditures and those dividends that aremore representative o interest costs. It does not necessarily represent the cashow in the period available or management to use at its discretion, which maybe afected by other sources and non-discretionary uses o cash.

o avoid conusion, a measure o Free Cash Flow that varies rom the above-noteddenition should not be described as Standardized Free Cash Flow.

Cash ows rom operating activities are the starting point or this denition asthey are generally the major source o internally generated cash. Tis denition isalso dictated by the recognition that Free Cash Flow is seen as a liquidity measure.Accordingly, Standardized Free Cash Flow reects cash consumed by or providedrom changes in working capital and will vary or the eects o seasonal, cyclicaland non-recurring activities. Some entities may view this as a discretionary use ocash. Te CPRB recommends that cash consumed by or provided rom changes inworking capital be included in Standardized Free Cash Flow or two reasons. First, the

Free Cash Flow measure should be consistent with the term cash used in its label.Second, the measure should be consistent with the GAAP statement o cash ows.Entities that wish to present Free Cash Flow without the eects o changes in workingcapital can provide an entity-specic measure.

otal capital expenditures or the period net o proceeds rom dispositions areincluded in the computation o Standardized Free Cash Flow as they represent theentitys re-investment o cash in continuing operations. Adjustments or capitalexpenditures are restricted to cash outlays in the period or tangible and intangiblecapital assets, including those major repairs and maintenance items that are capitalized

in accordance with GAAP.

Standardized Free Cash Flow includes all cash ows rom subsidiaries, whetherwholly or partially owned, as reported cash ows rom operating activities and capitalexpenditures are calculated on a consolidated basis.


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Cash distributions to shareholders other than certain dividends are excluded romthe calculation. Cash distributions to shareholders include share repurchases throughnormal course issuer bids or any other unit transaction executed in exchange orcash in the normal course o business. Te Standardized Free Cash Flow calculationexcludes common dividends and others that are declared at the boards discretion.When the dividend is stipulated, however, it should be reected in the computation,i paid. In these circumstances, the dividend is more characteristic o an interest costthan a discretionary distribution. I an entity views other dividends as being essentiallycompulsory distributions, which may be governed by the entitys circumstances, thenmanagement can incorporate this into its entity-specic measure o Free Cash Flow.

Disclosure o Standardized Free Cash Flow on a per share basis provides useul

inormation about the growth or diminishment o Standardized Free Cash Flowrom period to period. Even though Standardized Free Cash Flow is not a residualamount attributable to shareholders, per share disclosure is useul to compare cashow perormance to share prices. As well, it is a useul measure to compare againstdividends paid which are routinely reported on a per share basis. It should be noted,however, that in some jurisdictions securities regulators preclude disclosure o share-or unit-based cash ow inormation.

When a ully diluted cash ow per share calculation is presented, it should be based

on the eect o potential issuances o shares on the Standardized Free Cash ow perunit calculation.

Entity-specic Free Cash Flow disclosures

I entities adopt the preceding denition o Standardized Free Cash Flow, the resultwould be comparable rom entity to entity and consistent between periods. However,entities may believe that other adjustments should be made to cash ows romoperating activities in addition to those made in arriving at Standardized Free Cash

Flow.For example, there may be a cyclical or periodic nature to the pattern o cash owsgenerated rom operating and investing activities. In certain seasonal industries,inventory is built up (consuming cash) in the summer months, and is sold (producingcash) in the winter. In other circumstances, non-capitalized major repairs andmaintenance occur cyclically and result in cyclical patterns to operating cash ows,such as signicant scheduled maintenance activities once every three to ve years.In other industries, routine maintenance requires a multi-year cycle o capitalexpenditures on compressors or capacity rebuilds that may also require capacity to

be taken o-line or extended periods. Te relative predictability o the pattern osuch cash ows can motivate management to describe Free Cash Flow not in termso the actual historical cash patterns, but ater adjusting or the cyclical or seasonalcomponents o operating and investing activities. Tese cyclical patterns could be


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Free Cash Flow

communicated as part o the explanation o the variance in periodic Standardized FreeCash Flow. Cyclical events such as these may also be addressed by reporting an entity-specic Free Cash Flow that adjusts or such known patterns. In communicatingsuch cyclical patterns, signicant assumptions should be discussed. For example, anadjustment to eliminate the seasonal uctuations o working capital changes mayinvolve an assumption about uture selling prices.

Similarly, management may wish to communicate the special or non-recurring natureo certain transactions that in their view should not be part o a users reasonableexpectation o the uture cash ows. For example, restructuring charges are requentlydescribed as non-recurring (note that the securities regulators provide useul guidanceor dening non-recurring items in CSA Sta Notice 52-306). Entity-specic

adjustments may also include signicant commitments that an entity considersin determining the amount o cash available or discretionary activities, such assignicant commitments or uture capital expenditures to be unded rom operations.

Te term Free Cash Flow suggests that the measure should reect cash generatedin the period available or discretionary purposes. As noted, this is not necessarilythe case. For example, an entitys Free Cash Flow may be restricted by an operatingnancial covenant. Similarly, there can be restrictions on an entitys ability to utilizecash held in a subsidiary. Entities may wish to highlight circumstances such as these

through an entity-specic adjustment. Alternatively, these matters would be discussedas part o the nancing strategy discussed later in this guidance.

When an entity wishes to make entity-specic adjustments or items such as these,they should be identied separately rom the elements o Standardized Free CashFlow.


Te CPRB recommends that when additional entity-specic adjustments are made

in the computation o Free Cash Flow:

these amounts should be separately disclosed ater the computation oi.Standardized Free Cash Flow;

the adjusted amount should be reported as Adjusted Free Cash Flow;ii.

the purpose o each adjustment should be discussed;iii.

a reconciliation should separately disclose each adjustment between Adjustediv.Free Cash Flow and Standardized Free Cash Flow (or example, when anadjustment is made or working capital, each element o the adjustment, such

as seasonality and growth, should be explained);or each adjustment, the corresponding item in the nancial statements shouldv.be quantied; and,

the nancial statement component which contains the corresponding itemvi.should be identied.


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Tese Recommended Practices should assist investors to quickly assimilate andunderstand the nature, amounts, and reasons or entity-specic adjustments. Tisis acilitated when entity-specic adjustments are consistent rom period to period,both with respect to the nature o items adjusted and their computation. As well,adjustments should be consistent within the period. For example, when an adjustmentis made or non-recurring cash outows, there should also be an adjustment or anynon-recurring inows. When a change is made to the components o the entity-specic measure, users understanding will be enhanced i the reason or the change isexplained and comparative amounts are presented in accordance with the new basis.

When entity-specic adjustments include those in respect o working capital,accompanying disclosure should identiy the specic elements o working capital that

have been adjusted, together with the reasons or the change. As well, there may needto be disclosure o how working capital changes are expected to impact uture cashows and the reasons or those changes.

D. CONTEXTuAL DISCLOSuRES THAT

COMPLEMENT FREE CASH FLOW

As previously noted, the Free Cash Flow measure, used in isolation, has limitations.Accordingly, the CPRB believes it should be complemented by other disclosures toprovide a suite o inormation that enables a user to interpret the measure in theentitys specic circumstances.


o enhance communication o Free Cash Flow, entities should complementStandardized Free Cash Flow with additional disclosures about the entitys specic

circumstances with respect to:the relationship o Standardized Free Cash Flow to the entitys investing and(i)nancing activities;

the relationship o the entitys capital expenditures to its productive capacity(ii)strategy; and

nancing activities that are characterized as operating activities.(iii)

Relationship of Standardized Free Cash Flow to investing and

nancing activities

In eect, Standardized Free Cash Flow is a reorganization o the GAAP Statement oCash Flows to reect the interaction between an entitys cash ows rom operatingactivities and its capital expenditures. Understanding the entitys policies and actionswith respect to the other sources and uses o cash provides a more complete basis


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Free Cash Flow

or the analysis o Standardized Free Cash Flow. Tese other sources and uses ocash, categorized in the cash ow statement as nancing and investing activities,include cash distributions to common shareholders in the orm o dividends or sharerepurchases, debt and equity nancing, and mergers and acquisition activities.

Financing and investing activities may complement or compete with distributionsto shareholders as uses or any positive amounts o Standardized Free Cash Flow. Forexample, outside debt nancing may und all or a portion o the capital expenditureso an entity, and hence complement the Standardized Free Cash Flow. Conversely, therepayment (rather than renancing) o maturing debt or lines o credit may competewith dividends to shareholders as a use o Standardized Free Cash Flow.

Te relationship o an entitys Standardized Free Cash Flow to its investing andnancing activities may best be explained by providing an analysis o how thoseactivities complement and compete with Standardized Free Cash Flow. In addition,disclosure o the entitys nancing strategy will assist users to understand thisrelationship. Tis could include matters such as the entitys target debt to equity orleverage ratio, the degree to which it has xed but uncapitalized commitments suchas operating leases and purchase commitments, and the likelihood o compliancewith covenants. Some o this inormation should already be provided in the MD&Atable o contractual obligations and the statement o capital disclosures required by

Canadian GAAP.

Relationship of the entitys capital expenditures to its productive

capacity strategy

In order or an investor to make an assessment o the likelihood that an entitys FreeCash Flow will be sustained, he or she needs to understand the entitys strategy orproductive capacity and how that capacity is being maintained and grown. Tis couldbe acilitated i the entity were to dene how it views productive capacity, explain

how the capacity has been changing, and discuss how capacity has been aected by,or example capital expenditures, acquisitions, intellectual property, and inormationsystems. In particular, investors want to distinguish capital expenditures ocusedon growth rom those made to maintain existing levels o productive capacity. Tisdiscussion should also address the categories o capital asset expenditures and howeach asset category contributes to growth or productive capacity maintenance. Morediscussion about disclosure o productive capacity and productive capacity strategy isprovided in the CPRB guidance Standardized Distributable Cash In Income rusts AndOther Flow-Trough Entities.


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Financing-type activities that are characterized as operating

activities

In some cases, cash ows rom operations are aected by nancing-type activities thatare characterized as operating activities. Te cash ow may occur in close proximityto the transaction or may not arise or several years. In addition, these activitiesare subject to various degrees o management discretion. As previously noted,securitization o accounts receivable is an example o such a short-term transaction,substantially under managements control, that can have a signicant impact on aperiods cash ows rom operating activities.

Other transactions will not have an impact on periodic operating cash ows orseveral years. Examples o long-term operating items that are subject to timingdierences between accrual and expenditure are asset retirement obligations, ree rentarrangements, and deerred interest payments on discounted long-term obligations.Tese accrued items are non-cash operating transactions until unded. Te unding osuch amounts may be over the lie o the contract, such as ree rent obligations whichare deerred until rent is paid. Tey may also be paid at the conclusion or terminationo a contract, such as accrued interest on a debt instrument originally issued at adiscount, which is paid at redemption.

Such operating items may have a signicant eect on the entitys current and/or

uture Standardized Free Cash Flow. Accordingly, to be eective, the communicationo Standardized Free Cash Flow should identiy how such items impact current anduture cash ows. Te analysis should explain the extent to which such activities haveconsumed or provided cash in the period, and the extent to which they have deerredcash inows and outows to uture periods, including when such deerrals areexpected to aect Standardized Free Cash Flow. As well, the analysis should identiythe total amounts required to und obligations arising rom these activities and theamounts expected to be paid in each o the next ve years. Tis disclosure would besimilar to that required or conventional nancing transactions provided as part o the

table o contractual obligations.


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APPENDIX

SIGNIFICANT CHANGES TO

FEBRuARy 2008 DRAFT GuIDANCETe ollowing are the more signicant changes made to the earlier drat guidance as aresults o comments received.

I. GENERAL PRINCIPLESSection C. Te Characteristics o Non-GAAP Financial Measures has been amendedby adding a paragraph acknowledging that interim reports may disclose non-GAAPnancial measures on a trailing 12 month basis.

II. EBITDA

Section C. Denition and Disclosure o EBIDAhas been amended with respect tothe exclusions rom net income or net loss beore discontinued operations in arrivingat Standardized EBIDA. Te guidance now claries that these amounts are thosedisclosed in arriving at net income or net loss in accordance with GAAP.

III. FREE CASH FLOW

Section C. Denition and Disclosure o Free Cash Flowhas been amended to include

in the denition o Standardized Free Cash Flow proceeds rom the disposition ocapital assets, other than those o discontinued operations.

Section D. Contextual Disclosures Tat Complement Cash Flowhas been expandedto note that investors want inormation to distinguish growth capital expendituresrom maintenance capital expenditures.


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Notes


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ISBN-13: 978-1-55385-397-8

ISBN-10: 1-55385-397-0

Date post:	08-Apr-2018
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