Hi all,
- I am calculating a cost of debt for a company that has a significant position "Accrued severance pay" on its liabilities side (6% of all liabilities).
Should these be included in Debt in calculating the cost of capital, that is in calculating the proportions D/(D+E).
- On the assets side I have a position called "Severance pay fund" under Long Term receivables. What is that? Any ideas?
Thanks. Any ideas would be helpful. Any link to the literature/publication as to this positions would be also appreciated.
Is it a current liability? The only debt items you should include in your capital structure are those that are interest bearing.
Maybe the company purchased some unique insurance policy to fund the severance package. This could explain the receivable. Do the items match dollar for dollar? Are they in the ball-park?
What does the audit report say about these items? Should be included in footnotes.
edit: what is the purpose of your analysis?
I think you're "over financing" this a little bit with the insurance idea.
They took huge accruals for restructuring activities, but havent paid it out yet (if they ever will). Companies ALWAYS over estimate restructuring/severance costs when they take the P&L hit. I would look at when this went on the Balance Sheet. If it was taken recently then they likely havent paid out the severance yet. IF it's been out there a while then it's probably left over and wont be paid out (and basically becomes management discretion).
maybe, the audit should provide the detail necessary. we worked with a company who had a similar issue. That is the only reason I thought of it. In the scenario I worked with, the company brought on a few new executives with severance packages outlined in their employment agreements and simultaneously purchased insurance to offset the liability.
Where would the receivable come from in a restructuring?
No, it is not recent. It is a legal requirement in many countries in Europe and in israel, and that is where the workforce is.
It might be overstated, but no details are provided - so any assumption on my side is a speculation, so to say.
Thanks, first of all.
the purpose is valuation.
It is not a current liability. It is a separate position between, so to say (literally, actually), the current liabilities and Long-term liabilities.
The numbers are not in the ball-park: the severance pay fund is about half the size. They do mention that severance liability is fully provided by the monthly payments to insurance.
Although it is not interest bearing, it is a clear contractual obligation and legal requirement. You absolutely have a point in the sense that being a not interest bearing liability, it does not contribute directly to the cost of capital. On the other hand it might be triggered at any time and the main issue is that it is being taken into account in debt covenants. One would assume that it will be that way also in the future and as such it will impact the cost of debt and cap structure.. Therefore the confusion.
I am not sure what I do with that. a. Just dump it, simultaneuously reducing cash - but that is equal to assuming that all the employees just go.
b. Make it constant - but then I am assuming that number of employees does not change. And that is when I figure out why the severance pay fund is half the size of severance liability, and they are stating that the liability is fully provided for.
c. Treat it similarly to working capital - i.e try to tie that to revenues or some other driver and take it into account as a separate factor in FCF calculation.
all thoughts are welcomed.
Cheers
What is the purpose of the valuation?
So to my understanding, it is a legal obligation causing the company to have insurance or some sort of "slush fund" available for severance? Is any severance pay running through the PL or just the insurance premium expense? I think it is important to understand how exactly the liability is "fully funded," since the receivable is lower than the payable.
If the liability is fully funded through the insurance product, then these balance sheet items are moot. Just make sure the insurance premium expense is passing through the PL.
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