The simulated FHR is the FHR adjusted for abnormal items by adding or subtracting the abnormal amount from the operating income. Simply put, it's what the FHR would have looked like if the abnormal item(s) did not exist.
We define an abnormal item as an operating gain or loss explicitly classified by the company or its auditors as abnormal because it is either a) unlikely to occur again or b) represents an unusual magnitude. |
We're often asked if the actual rating should be disregarded in favor of the simulated rating - we caution that this should only be done while considering the potential cost should the abnormal item prove symptomatic of larger issues (i.e. it's not abnormal at all!).
We recommend using the FHR as the source of truth and referring to the simulated FHR for additional insights. |
Examples of typical abnormal items include:
Restructuring costs: A restructuring charge might be incurred in the process of furloughing or laying off employees, closing manufacturing plants, shifting production to a new location, or writing off assets.
Merger or acquisition costs: These occur when a company is engaging in a merger or acquisition of another firm.
Asset impairment / write down (if operating asset): This occurs when the company recognizes that assets are not worth the book value at which they had been recorded. Once a company has determined that an asset is impaired, it can write down the asset or classify it as an asset for sale. Assets will be written down if the company continues to use them. Impaired assets held for sale are assets that are no longer in use and are expected to be disposed of or abandoned. Events that could lead to asset impairment include (but are not limited to) changes in regulation, technologies, or business climate or declines in usage rate.
Goodwill impairment: This occurs when a company decides to pay more than book value for the acquisition of an asset, and then the value of that asset declines. The company has to adjust the book value of that goodwill down if it becomes impaired.
Litigation settlement costs (if related to operating activities): Common litigation relates to contract disputes with their debtors (customers), creditors (suppliers), and joint venture partners to name a few. The shareholders themselves could also be subject to legal action, which could impact the company should they guarantee the counterparties' financial obligations.
Goodwill amortization: This refers to the gradual and systematic reduction in the amount of the goodwill asset by recording a periodic amortization charge.
We currently do not simulate events that are not listed on the financial statements, however, ActionPath allows you to set strategies and targets to see how they impact your FHR to undertand the change before you invest into implementing them.