Using the most recent balance sheet amount of net debt in enterprise value could produce misleading valuations. Several adjustments may be necessary, including for seasonal fluctuations and where fair value differs from book value.
European travel company TUI is a good example of where the balance sheet net debt may be problematic. We explain when and how to adjust net debt, and why financial statements only partially help. We also consider whether a direct equity valuation, such as using a price earnings ratio, can eliminate net debt complications.
Both equity and enterprise value (EV) based valuations need to reflect the claim of debt providers on the business. If a greater portion of the wealth created by a business accrues to debt holders, less is available for equity investors. How this debt claim is dealt with depends on whether a direct or indirect approach to equity valuation is used.
- For direct equity valuation, based on a price earnings ratio or a discounted equity cash flow model, the debt claim is included by using a post-interest measure of earnings or an equity free cash flow after allowing for debt cash flows. Debt is not included in absolute terms but rather as a flow.
- For indirect equity valuation, the value of an operating business is initially calculated, and from this the absolute amount of debt claims is deducted. Further adjustment for other financing claims and the addition of non-core and financial assets may also be required. These valuations can be based on EV multiples or a discounted enterprise free cash flow approach. An absolute amount of net debt is included in the market EV used for multiples and (generally) the same amount1If a DCF valuation produces a target EV that differs from the current market EV, that difference should be allocated between debt and equity claimholders resulting in a debt claim that may differ from the current fair value. In practice such an allocation of value differences to debtholders is often ignored or assumed to be immaterial. is deducted in the EV to equity bridge as part of an enterprise DCF valuation.
The present value of the debt flow included in a direct approach should equal the absolute value of the debt claim deducted in the indirect approach. Therefore, at least in theory, the two methods should produce the same ultimate valuation.
Enterprise value is usually based on net rather than gross debt, with cash balances regarded as financing rather than operating. Sometimes we see investors include some or all cash within net working capital and not include it in EV. This is approach is fine, except trying to split total cash in operating and excess cash can be challenging, and often somewhat arbitrary. We generally recommend including all cash and other liquid assets (cash equivalents) in net debt metrics, although the adjustment below in respect of seasonal debt, in effect, designates a variable amount of cash (or debt) as operating.
EV based valuations are more comparable if leverage differs
In our experience, most enterprise value based valuations, whether EV multiples or DCF, feature the unadjusted balance sheet amount of net debt. Although net debt used in valuations should theoretically be the amount at the valuation date (unless multiples are historically priced2Historical priced multiples combine a historical performance metric with a historical stock price or historical EV – often the average for the period covered by the performance metric. These multiples are used to analyse trends in valuation and as a comparison with current priced multiples. For more about the pricing basis for valuation multiples, see our article ‘Why you should forward price valuation multiples’.), the most recent published amount taken from the latest annual or quarterly results is generally used as a proxy. Sometimes this is updated to reflect an obvious change in debt since the latest reporting date, such as due to a major transaction, but generally no further adjustment is made. There are several potential problems with this approach.
Seasonal variation in net debt
Many businesses have a significant variation in activity throughout the year, the cash flow effects of which result in seasonal changes in debt and cash balances. The tourism sector is a good example, with the end of the lucrative summer season likely to result in the lowest amount of net debt3TUI says that its peak cash flow is at the start of the European summer, but the peak cash balance is later than that, as illustrated in the chart below.. European tour operator TUI provides the following explanation:
Tourism is inherently seasonal with the majority of business undertaken and profits earned in the European summer months. Cash flows are similarly seasonal, peaking in early summer as advance payments and final balances are received from customers, and dipping in winter as liabilities are settled with many suppliers after the summer season. (“The touristic swing”).
The following chart shows the significant quarterly variation in the balance sheet book value of net debt of TUI. The company has a September year-end, which coincides with the lowest net debt figure.
TUI reported and (estimated) seasonally adjusted net debt
TUI financial statement data and The Footnotes Analyst estimates. We define net debt as current and non-current financing and lease liabilities less cash and cash equivalents.
There are various ways to estimate a seasonally adjusted net debt amount, with no perfect answer. Quarterly reporting helps a lot, but even this frequency of reporting may not be sufficient to fully capture the seasonality effect. In our calculations above we have estimated the seasonally adjusted amount by taking the average of the last 4 quarterly deviations from a linear annualised trend.
Where material, always seasonally adjust net debt
We think it is important to use a seasonally adjusted net debt in all enterprise value metrics and EV based valuations. Only then will the debt amount reflect the interest that accrues during the period and therefore produce a valuation that is consistent with a direct equity approach. Where a business is seasonal, the balance sheet amount may misrepresent the true debt burden on a business and how much of the value of an enterprise accrues to equity investors. It would also clearly be incorrect for the derived equity value to fluctuate each quarter simply because of the predictable seasonal variation, which would be the consequence of using the most recent balance sheet amount without adjustment.
Unsurprisingly TUI refers to the seasonality of its business and net debt position several times in its financial statements. Although the company does not provide any data directly related to enterprise value, it does give a measure of invested capital used in ROIC metrics, for which the same seasonality issue applies.
TUI invested capital with seasonal debt adjustment
TUI 2025 financial statements
The seasonality adjustment included by TUI is €500m, with the amount unchanged over recent annual reports. Based on our calculation this adjustment seems somewhat low – we estimate an adjustment to the latest fiscal year-end net debt of €1,167m. The discrepancy may be because the company seems to only consider the seasonality of its cash balance rather than also that for debt. Of course, the company also has more detailed data than available to us – or maybe the company has simply not recently updated the amount.
The effect of the seasonality adjustment to net debt for TUI is certainly material for equity valuation. Using book values for other components of EV (see below for discussion about fair value), and based on current market capitalisation, the adjustment increases enterprise value and EV multiples by 21%.
TUI EV/EBITDA with and without seasonal net debt adjustment
TUI September 2025 financial statements and The Footnotes Analyst estimates. Market capitalisation is as at January 7th, 2026. Other components are book values at 30th September 2025 – see below for further adjustments that may be required to these amounts. Forecast 2026 EBITDA is taken from Market Screener. Interestingly, Market Screener does not make any adjustments for debt seasonality in their leverage and valuation metrics.
Fair value of net-debt
When determining enterprise value or adjusting value in the DCF enterprise to equity bridge, it is the fair value of the debt claim that matters. Enterprise value is the sum of the fair values of the various claims on the underlying business – book value is irrelevant. One way to think about it is to imagine purchasing the underlying business by acquiring the equity, debt and other claims each of which would have to be purchased at their market value.
The balance sheet book value of debt will mostly be a historical cost measure and should be adjusted if fair value differs materially. Fair values of financial assets and liabilities are always disclosed in the footnotes, so it is not difficult to identify whether this is needs to be considered. Obviously if the effect looks to be immaterial it can be ignored
TUI discloses that the fair value of its debt liabilities exceeds their book value by €192.7m, most of which seems to be accounted for by three bond issues, including two convertibles, for which a separate disclosure is provided.
TUI bond fair value disclosures
TUI 2025 financial statements
Convertible bonds add another layer of complexity for enterprise value due to the bifurcation of the instruments in IFRS financial statements. The book value of the liability component of a convertible excludes the value of the conversion option, the initial value of which is included in shareholders’ equity. It is the fair value of the full convertible, including the value of the conversion option, that must be included in enterprise value, which we think is what the above fair value disclosure provides. However, you must be careful not to double count.
One common mistake is to allow for the conversion option by increasing the share count for the dilution effect whilst also including the full value of the convertible in net debt. Using a diluted share count for market capitalisation may produce a reasonable answer if the book value of only the debt component of the convertible is included in EV, but not if the full fair value is used.4For more about convertibles see our articles ‘Convertible accounting: New US GAAP inflates earnings’ and ‘Cost of capital for convertibles’.
Lease liabilities are measured at cost – and (unlike debt finance) no fair value disclosures
Net debt should also include the fair value of lease liabilities. As with debt finance, the balance sheet amount is measured at amortised cost – i.e. the liability recognised at lease inception with adjustments for subsequent flows and interest accretion. If, as is generally the case, the interest rate implicit in the lease is fixed, a change of rates can result in a fair value that differs from the balance sheet book value, just as for fixed rate debt.
Unfortunately adjusting the book value of leases to fair value in practice is very difficult as, unlike other debt, neither IFRS nor US GAAP require this disclosure. If leases are relatively short-term it is likely the fair value adjustment would be small anyway, but if leases are long term, and significant in book value terms, more analysis may be necessary. A rough estimate of fair value should be possible by comparing the disclosed average (historical) discount rate applied to its leases with current borrowing rates.5A simple approach is to estimate the average duration of lease liabilities and multiply this by the difference between the estimated current borrowing rate and the disclosed average historical rate applied in the amortised cost measurement of the leases. This calculation will produce an estimated percentage difference between book value and fair value.
The lease liabilities of TUI are certainly material (see table below) and their duration sufficient to warrant further investigation of a potential difference between book value and fair value. Unfortunately, the company does not appear to disclose the average incremental borrowing rate applied in measuring the amortised cost of these liabilities, although we can derive an estimate by dividing the lease interest accretion by the (average) lease liability during the year. Using this approach, we estimate the fair value to be somewhat above book value, but probably not by enough to require adjustment.
TUI net debt disclosure
TUI 2025 financial statements
While we focus on the fair value of net debt in enterprise value in this article, it is worth noting that TUI has two other components of EV for which fair value adjustments will probably be important. For both non-controlling interests and investment in associates, the balance sheet carrying amount is amortised cost and not fair value. Often the difference between book value and fair value is much greater than for debt finance. Like leases there is no requirement to disclose fair value for either of these in the financial statements and investors are left to make their own estimates.
We discussed the measurement of associates in our article ‘No insight for investors from equity accounting’. For a more wide-ranging analysis of the lack of fair value disclosures see ‘Enterprise to equity bridge – More fair value required’.
Financing related derivatives and net debt
If derivatives have been used to hedge interest rate or currency exposures in debt financing, their fair value should also be included in the calculation of enterprise value. These derivatives create cash flows that are not included in operating profit and enterprise free cash flow. Only by including the fair value of these derivatives in EV or the enterprise to EV bridge will these flows be included in any valuation.
One of the challenges for investors is identifying which derivatives relate to financing and which relate to operating activities. As a result, this net-debt adjustment is frequently ignored, particularly if the amount is likely to be insignificant.
In the case of TUI, derivatives are mainly used to hedge interest rate, currency, and commodity price risks. We think only the interest rate related derivatives are likely to relate to financing and should be included in enterprise value. However, the value of interest rate hedging derivatives in 2025 was immaterial.
Interestingly, TUI regards all of its derivative balances as financing for the purpose of its calculation of invested capital and ROIC (see the extract above). We do not agree with this approach and would regard the derivatives (excluding the vary small amount attributable to interest rate hedges) as operating assets and liabilities. It is for this reason we do not include any derivatives in our TUI EV calculation above.
Separate classification of financing related assets and liabilities in the balance sheet
What would help investors (which we have previously advocated) is an analysis of the balance sheet using an ‘operating–investing–financing’ type classification. The IASB has recently introduced this for the income statement through the requirements in IFRS 186See our article ‘Why IFRS 18 is good news for investors’., which we think will help investors enormously, but sadly this was not extended to the balance sheet – maybe one day?
If financing related derivatives are included in net debt at fair value, it is also important to make sure the related debt financing is at fair value as well. Sometimes this will in effect be done for you. Suppose a company has fixed rate debt and uses a fixed-to-variable interest rate swap to convert this to a synthetic variable rate. In this case, the fair value of the derivative will be largely offset by the change in fair value of the hedged debt; but if fair value hedge accounting is applied the fair value adjustment (at least in respect of the hedged benchmark interest rate risk) would be included in the book value of the debt finance. This still leaves the fair value effect of a change in credit spread, but at least the debt is partly at fair value.
Our advice is to not try to tailor your adjustments based on hedge accounting and to simply restate all debt to fair value using the provided disclosures and include all financing related derivatives (the balance sheet value for which is already fair value).
Valuation date adjustments of net debt
The final net debt adjustment that is important for investors is to allow for the valuation date being different from the balance sheet date. Net debt is generally taken from the most recent balance sheet§, subject to the seasonality and fair value adjustments we explain above. However, if the valuation date for a multiple or DCF model does not coincide with an accounting period end an adjustment is necessary to ‘roll-forward’ net debt (or roll-back if a forecast).
Such an adjustment is most important when there is a significant time difference between the last balance sheet date and the valuation date, and the company is generating significant enterprise free cash flow. The adjustment should equal an apportionment of current period enterprise free cash flow less the estimated equity cash flow (dividends plus buy-backs) and interest payments for that same period. Another approach is to simply interpolate between the most recent net debt and the first forecast net debt in your forecasting model.
Correctly adjusting net debt to the current valuation date also ensures that you do not get difficult to explain changes in your target price when the next balance sheet date arrives. All target price changes should reflect a change in forecasts rather than being due to a mechanical effect of a roll-forward of a model.
For more about valuation date adjustments see our article ‘DCF models: Valuation date and cash flow timing’.
What about using a direct equity valuation instead?
The alternative to enterprise value is to base valuations directly on equity flows, the most common version of which is the price earnings ratio. This has the advantage of solving some of the problems we identify above and therefore avoiding some of the adjustments.
- Seasonality: Earnings automatically considers the seasonality of net debt considering that the interest accretion is based on the actual amount of debt outstanding at any point in time. Beyond forecasting the net interest expense (for which seasonality is clearly a factor to consider in your model) no further adjustment is required.
- Fair values: This is where earnings present a problem. The interest expense included in earnings is largely based on amortised cost measurement of net debt, which may not equal the current cost. This is not a problem if you allow for the refinancing of current debt and incorporate the revised interest expense in earnings and cash flow forecasts and these long-term effects are factored into your valuation model. However, considering that price earnings based valuations generally use short-term forecast metrics, the full effect of refinancing is unlikely to be captured in practice.
- Financing related derivatives: The good thing about using earnings is that there is no need to differentiate between financing and operating related derivatives because the flows from both are reflected in earnings. These flows do not necessarily reflect the fair value impact of the derivatives and, as for the fair value of net debt, you should look beyond the short-term earnings forecast to identify whether the overall value effect is not being captured by the price earnings ratio7Suppose a company has used a swap to fix interest on variable rate debt and it currently pays below market rates due to the swap. The swap matures in say 3 years when the related debt will be redeemed and refinanced. Focusing just on short-term earnings without considering the increased interest payments in 3 years’ time may lead over valuation. An enterprise value approach, with derivatives and debt included at fair value, will allow for the duration of the reduced interest.
- Valuation date adjustments: This is also less of an issue in a price earnings valuation given that the only date-specific metric is the stock price, which is automatically available. Only in a discounted equity cash flow valuation will an adjustment be required based on the same methodology for an enterprise value DCF, as described in our earlier article.
Leverage effects still make PE ratio comparisons challenging
While it appears that direct equity valuation, and the ubiquitous price earnings ratio, can be easier to apply, particularly when seasonality is an issue, we still prefer an indirect enterprise value based approach to valuation. This is mainly because of the leverage effects that make comparison of PE ratios so challenging. It can be very difficult to identify when a difference in PE multiple is simply a mechanical result of the financial leverage effect or due to a true underlying valuation difference. See our article ‘Enterprise value: Our preference for valuation multiples’ for more about the leverage effect.
Insights for investors
- While commonly used in practice, the most recent balance sheet net debt may not be the correct amount to include in an enterprise value multiple or in a DCF enterprise to equity bridge.
- Adjust for the seasonality of net debt if the effect is material. The correct debt burden that impacts equity investors is the average debt outstanding during the year, and not the year-end position.
- A market enterprise value, and the adjustments in the enterprise to equity bridge, should reflect the fair value of all claims, including net debt. Look for the fair value disclosures for debt liabilities in financial statements and consider whether a similar adjustment may be necessary for lease obligations.
- Include financing related derivatives in enterprise value but not those related to operations, the flows for which will feature in operating results.
- Direct equity valuations, such as a price earnings ratio, avoids some of the net debt challenges but remember that the financial leverage effect can make PE ratio based comparisons difficult. We still prefer EV based valuations.