The Simulated FHR is the FHR adjusted for abnormal items by adding/subtracting the abnormal amount from operating income. Simply put, it's what the FHR would have looked like if the abnormal item(s) did not exist.
RapidRatings defines 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
Clients often ask if they should disregard the actual rating in favor of the simulated rating - we caution that this should only be done with consideration to the potential cost should the abnormal item prove symptomatic of larger issues (i.e. not abnormal at all!)
We recommend using the FHR as your primary risk signal, and refer to the simulated FHR used for additional insight
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. When a company restructures, it is usually experiencing significant problems and restructuring is an attempt to improve the business and recover financially
- Merger or acquisition costs: These occur when when a company is engaging in the merger or acquisition of another business
- 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 keeps on using this asset. 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 and business climate, declines in usage rate and technology changes
- 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 (clients), 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
There's an in-depth section of the FHR Report (Section 4) that covers the Simulated FHR for public companies in our coverage, as well as private companies that have allowed full disclosure.
We currently do not simulate events that are not listed in the financial statements.