In FY2020 a number of Indian retailers reported sharply higher debt and sharply higher EBITDA in the same year. They had not borrowed more, and their stores had not become more profitable. The change was entirely presentational — and if you are screening companies on ratios without knowing this, it will mislead you.
What Actually Happened
Ind AS 116 required lessees to recognise a right-of-use asset and a lease liability for leases that were previously off balance sheet.
Three mechanical consequences follow, and every ratio effect flows from them:
- Assets and liabilities both increase
- Rent expense is replaced by depreciation and interest, both below the EBITDA line
- Principal repayment moves from operating to financing cash flow
The Ratio Effects
| Metric | Direction | Why |
|---|---|---|
| Total assets | ▲ Up | ROU asset added |
| Total liabilities | ▲ Up | Lease liability added |
| Equity | ▼ Slightly down | Front-loaded expense reduces early retained earnings |
| Debt-to-equity | ▲ Up sharply | Numerator rises, denominator falls slightly |
| EBITDA | ▲ Up | Rent removed from operating expenses |
| EBIT | ▲ Slightly up | Depreciation is usually less than the old rent |
| Interest cover | ▼ Down | Interest expense rises |
| Net profit (early years) | ▼ Down | Front-loading |
| Net profit (later years) | ▲ Up | Front-loading reverses |
| Current ratio | ▼ Down | Current portion of lease liability added |
| ROCE | ▼ Down | Capital employed rises |
| ROA | ▼ Down | Asset base rises |
| Asset turnover | ▼ Down | Same revenue on a larger asset base |
| Operating cash flow | ▲ Up | Principal reclassified to financing |
| Free cash flow | ▲ Up as commonly calculated | Operating cash flow rises; lease principal sits in financing |
| Total cash | — Unchanged | No change in money actually paid |
The Two That Matter Most
EBITDA rose without anything improving
EBITDA excludes depreciation and interest by construction. Moving rent out of operating expenses and into those two lines mechanically increases it.
For a lease-heavy retailer this can be a large effect. Any valuation multiple built on EBITDA — EV/EBITDA in particular — is not comparable across the adoption boundary, and comparisons between a leasing company and an owning company shifted meaningfully in the leasing company’s favour on that metric.
Debt-to-equity rose without any borrowing
Lease liabilities sit in the debt figure that most screeners and covenant calculations use. A retailer with modest bank borrowing and hundreds of leased stores could see its reported leverage transform.
This caused real practical problems at the time: loan covenants written against pre-Ind AS 116 definitions were breached on paper by companies whose actual position had not changed, and many required renegotiation or explicit carve-outs.
Free Cash Flow — the Subtle One
This deserves care because the standard FCF formula is affected in a way that is easy to miss.
Free Cash Flow = Cash Flow from Operations − Capital Expenditure
Post-Ind AS 116, operating cash flow rises because lease principal moved to financing. Capital expenditure is unaffected — ROU assets are not purchased. So FCF as conventionally computed rises, even though the company pays exactly the same rent.
An analytically cleaner treatment subtracts lease principal repayments from FCF, restoring comparability with the pre-adoption position and with companies that own rather than lease.
How to Compare Fairly
| Situation | Approach |
|---|---|
| Company across FY2019 → FY2020 | Read the transition note; do not treat the series as continuous |
| Lease-heavy vs asset-owning peer | Both now capitalise — comparison is better than before |
| Indian company vs US GAAP peer | US GAAP retained a dual model; EBITDA is not comparable |
| EV/EBITDA screening | Ensure lease liabilities are consistently in or out of EV and EBITDA |
| Debt covenant analysis | Check whether the covenant definition includes lease liabilities |
The middle row is the genuinely positive outcome. Before Ind AS 116, an airline leasing its fleet and one owning it looked structurally different. Now both show the asset and the obligation, which is what the standard was designed to achieve.
A Note on US GAAP
IFRS 16 and Ind AS 116 apply a single lessee model. US GAAP under ASC 842 retained a dual classification — finance and operating leases — with operating leases producing a single straight-line expense within operating costs.
The practical effect: a US company’s EBITDA still absorbs operating lease cost, while an Indian or IFRS company’s does not. Cross-border EBITDA comparisons for lease-heavy businesses require adjustment.
What to Read in the Accounts
- Transition note in the adoption year — states ROU asset and lease liability recognised
- Maturity analysis of lease liabilities — shows the commitment profile
- Weighted average incremental borrowing rate — affects the size of the liability
- Short-term and low-value lease expense — leases kept off balance sheet under the exemptions
- Variable lease payments — sales-linked rents excluded from the liability entirely
That last item is easy to overlook. A retailer on turnover-linked rents reports a smaller lease liability than one on fixed rents for economically similar stores, because variable payments tied to sales are excluded from measurement.
Key Takeaways
- Ind AS 116 changed presentation, not economics — cash paid is identical
- Debt-to-equity rose sharply for lease-heavy companies with no new borrowing
- EBITDA rose because rent moved below the line
- ROCE, ROA and asset turnover fell on a larger capital base
- Operating cash flow and conventional FCF rose as principal moved to financing
- Comparatives were generally not restated — the FY2019/FY2020 boundary is a break
- US GAAP kept a dual model, so cross-border EBITDA needs adjustment
- Sales-linked variable rents are excluded from the liability, reducing comparability between retailers
Frequently Asked Questions (FAQ)
Q: How did Ind AS 116 affect debt-to-equity ratios?
It raised them, often sharply, for lease-heavy companies. Lease liabilities previously disclosed only in notes moved onto the balance sheet, increasing reported debt with no new borrowing. Equity also fell slightly due to front-loaded expense recognition.
Q: Why did EBITDA increase after Ind AS 116?
Rent expense, which sat within operating costs, was replaced by depreciation on the right-of-use asset and interest on the lease liability. Both fall below the EBITDA line, so EBITDA rose mechanically without any improvement in performance.
Q: Did companies actually pay more after Ind AS 116?
No. Cash outflow was unchanged and total expense over the lease term was unchanged. Only recognition, classification and the timing profile of the expense shifted.
Q: Can I compare EV/EBITDA before and after Ind AS 116?
Not directly. EBITDA rose post-adoption while enterprise value may or may not include lease liabilities depending on how it is computed. Ensure lease obligations are treated consistently in both the numerator and denominator, and be cautious comparing across the adoption year.
Q: Does Ind AS 116 make lease-heavy and asset-owning companies more comparable?
Yes, and this was the point. Previously an airline leasing its fleet showed neither asset nor debt while one owning an identical fleet showed both. Now both recognise the asset and the obligation, which improves comparability materially.
Q: How does Ind AS 116 affect free cash flow?
Conventionally calculated FCF rises, because operating cash flow increases when lease principal moves to financing while capital expenditure is unaffected. A cleaner approach subtracts lease principal repayments to restore comparability.
Q: Is EBITDA comparable between Indian and US companies after this change?
Not for lease-heavy businesses. US GAAP under ASC 842 retained a dual model where operating leases produce a single straight-line expense within operating costs, so US EBITDA still absorbs that cost while Indian and IFRS EBITDA does not.
Q: Why do two similar retailers report different lease liabilities?
Often because of rent structure. Payments linked to store sales are excluded from the lease liability and expensed as incurred, while fixed or index-linked rents are included. A retailer on turnover-linked rents therefore reports a smaller liability for economically similar stores.
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