Today I feel like a bar-room topic: net debt. At the bar everyone knows what a company is worth. Take the EBITDA, multiply it by whatever number you like best, and there is your price. In twenty years of business I have sold companies and valued many others, and I recently added the piece of paper that explains the theory (enrolled at university at 41, graduated in under two years). And yet the thing that still makes me sit up in a negotiation is not the multiple. It is a line nobody mentions at the bar, because to understand it you have to read the definitions at the back of the contract: the net financial position, net debt for short. That is the whole point of this piece: the value of a company is not revenue minus costs, and what sits below the profit line, debt, cash and a grey zone of commitments the balance sheet does not call debt, decides how much you actually take home. And, if you are not selling, it decides how much room you have to breathe.
What net debt is, explained to people who are not accountants
Net debt is the difference between financial debt (banks, bonds, shareholder loans, finance leases) and liquidity (cash plus financial assets you can turn into cash quickly). Positive means more debt than cash, negative means net cash. A warning from someone who has fallen for it: many Italian financial statements use the opposite sign convention, so always ask which sign the number was written with before you do any arithmetic.
Think of a house with a mortgage: it is worth 300, the outstanding mortgage is 100, you pocket 200. Net debt is the mortgage. And if the house comes with unpaid condominium fees, the buyer deducts those too, because he is the one who will pay them.
From the value of the company to the money the seller receives
EBITDA is the gross operating margin, a rough proxy for the cash the business produces. Multiplied by a market multiple it gives the Enterprise Value, the value of the company regardless of who financed it. The seller, however, receives the Equity Value: Enterprise Value minus net debt. Offers are written cash-free debt-free, as if the company had neither cash nor debt, and are then adjusted with the real numbers. The other adjustment, the one on working capital, is the subject of the twin article.
How to calculate it: the ESMA schedule and row K
Uncomfortable fact: neither Italian GAAP (OIC) nor IFRS define net debt. The reference everyone borrows is the ESMA Guidelines of 4 March 2021 (ESMA32-382-1138, Guideline 39, paragraphs 175-189), adopted in Italy by CONSOB with warning notice 5/21: written for listed companies, they are the common language in SME negotiations too. Here is the schedule, with the numbers of an imaginary company (thousands of euro) that I will use throughout the article. The rows in bold are totals, the others are the items that make them up.
| Item | €k | |
|---|---|---|
| A | Cash | 1,205 |
| B | Cash equivalents | 0 |
| C | Other current financial assets | 300 |
| D | Liquidity (A+B+C) | 1,505 |
| E | Current financial debt (invoice advances 900, shareholder loans 400) | 1,300 |
| F | Current portion of non-current financial debt | 700 |
| G | Current financial indebtedness (E+F) | 2,000 |
| H | Net current financial indebtedness (G−D) | 495 |
| I | Non-current financial debt | 2,800 |
| J | Debt instruments | 0 |
| K | Non-current trade and other payables | 200 |
| L | Non-current financial indebtedness (I+J+K) | 3,000 |
| M | Total financial indebtedness, i.e. net debt (H+L) | 3,495 |
On an Italian statutory balance sheet (art. 2424 of the Civil Code) these are liability items D1-D5 net of current asset items C.III and C.IV, with two traps that cost money: the residual lease debt ESMA wants included sits only in the notes, and intragroup financial debt hides in D9, D10 and D11.
The 2021 novelty almost nobody applies is row K: trade payables due beyond twelve months are part of net debt, because a company that pays its suppliers beyond a year is financing itself with its suppliers. In the example that is 200 thousand euro: under the previous schedule net debt would have been 3,295. Same balance sheet, two hundred thousand euro of difference, just by changing the definition.
What stays out of net debt, and why
This is where the most common mistakes show up, and I have made them myself. The rule is one: net debt includes what finances the company, or what will leave the cash account for the past; it excludes what turns with the business. So out go trade payables due within the year, trade receivables, inventory, customer advances, the current taxes you will pay on the normal due date. Not because they do not matter, but because they matter somewhere else: they are working capital, and they have their own separate adjustment. Counting them twice is the fastest way to start a fight at the table.
Three cases where the same item switches sides. Taxes: current ones are working capital, instalments or arrears are debt, because the State is extending you credit. Suppliers: within the year working capital, beyond the year row K. Guarantees: they are not on the balance sheet, so they are not in net debt, but a serious buyer asks for them anyway. And one thing net debt never is: the cash you can spend tomorrow. Negative net debt, meaning net cash, says nothing about how much of that cash is restricted or already promised to next month.
The items the buyer adds and the seller forgets
The ESMA schedule is the floor, not the ceiling. Above it sit the debt-like items: things the balance sheet does not call debt but which are cash leaving the company after closing for obligations born before it. Restricted cash, tax and social security instalments or arrears, negative-value derivatives, residual earn-outs, declared and unpaid dividends, provisions with a probable outflow. Then the two contested items: the TFR (the Italian statutory severance accrual: a liability to employees for the balance sheet, cash that will leave for the buyer), which usually ends up split down the middle; and structural non-recourse factoring, which makes receivables vanish from the balance sheet but finances working capital with an instrument that can vanish when the shareholder changes.
What the perimeter is worth: the example in numbers
Outside the schedule, but inside the negotiation, our company has: restricted cash 250, tax instalments 470, a negative swap 45, a residual earn-out 150, declared dividends 200, a litigation provision 70, TFR 650 and structural factoring 800. With EBITDA of 1,800 and a 6.0x multiple the Enterprise Value is 10,800. Equity Value, in every row, is always the same calculation: 10,800 minus the net debt of that perimeter.
| Net debt perimeter | Net debt €k | Calculation | Equity €k |
|---|---|---|---|
| Pre-2021, without row K | 3,295 | 10,800 − 3,295 | 7,505 |
| Pure ESMA (the seller’s position) | 3,495 | 10,800 − 3,495 | 7,305 |
| Adjusted base (ESMA + restricted cash, instalments, swap, earn-out, dividends, provision: +1,185) | 4,680 | 10,800 − 4,680 | 6,120 |
| Maximalist (adjusted + TFR 650 + factoring 800) | 6,130 | 10,800 − 6,130 | 4,670 |
Between the pre-2021 schedule, the perimeter most favourable to the seller, and the aggressive buyer’s there is a swing of 2,835 thousand euro: 26% of the Enterprise Value and more than a third of what the seller thought he would receive, with the same EBITDA and the same multiple. Crossing multiple and perimeter shows where the game is really played. Every cell is the row’s Enterprise Value minus the column’s net debt: 9,000 minus 3,295 is 5,705, and so on.
| Multiple (Enterprise Value) | Pre-2021 (net debt 3,295) | ESMA (3,495) | Adjusted (4,680) | Maximalist (6,130) |
|---|---|---|---|---|
| 5.0x (EV 9,000) | 5,705 | 5,505 | 4,320 | 2,870 |
| 5.5x (EV 9,900) | 6,605 | 6,405 | 5,220 | 3,770 |
| 6.0x (EV 10,800) | 7,505 | 7,305 | 6,120 | 4,670 |
| 6.5x (EV 11,700) | 8,405 | 8,205 | 7,020 | 5,570 |
| 7.0x (EV 12,600) | 9,305 | 9,105 | 7,920 | 6,470 |
Winning half a turn of multiple, from 6.0x to 6.5x, is worth 900 thousand euro and usually costs weeks of negotiation and a fair amount of heartburn. Moving from ESMA to maximalist is worth 2,635, almost a turn and a half, and it is decided in one clause almost nobody reads.
Why December net debt is the prettiest of the year
Net debt is a snapshot, and the seller picks the date: almost always 31 December. In our company monthly net debt swings between 5,300 in March and 3,495 in December, with a twelve-month average of 4,583: 1,088 thousand euro more than the year-end figure, 31% higher. It is not fraud, it is routine window dressing: in November you chase collections, slow down payments and run down inventory. Whoever buys on the December snapshot pays for a company that carries a million more debt for eleven months of the year. That is why I always ask for monthly net debt over the last twelve or twenty-four months, and if you are selling, bring it yourself: nothing builds credibility like handing the buyer the number he would have found on his own.
What monthly net debt tells you if you have no intention of selling
This is the part I care about most, because most of the entrepreneurs I know see their net debt once a year, from the accountant, as a balance-sheet figure they usually do not understand. I treat it as a dashboard, and I look at it over twelve months in a row. It says three things the annual number hides.
The first is seasonality: the March peak, in our example, tells you how much credit line you really need, not how much the bank gave you. If the peak grows year after year with flat revenue, working capital is eating you, and you find out here before you find out in late payments. The second is the trend: put net debt next to EBITDA. The ratio between the two says how many years of margin it takes to repay the debt, and it is the first number a bank looks at, before it even looks at you. If net debt grows faster than EBITDA you are financing growth with debt, or you are losing margin and have not seen it in the income statement yet. Neither is necessarily a mistake, but it has to be your decision, not a surprise from the auditor. The third is the distance between the December figure and the average: if it is large, your company is more indebted than the accounts say, and every decision on investments, dividends and hiring should be made on the average number, not on the pretty one.
For medium-term strategy that is enough: a sheet with twelve rows, net debt and EBITDA side by side, updated every month. I know, it is boring. It is also why almost nobody does it, and therefore why whoever does sees the curves before everyone else.
Where the deal is really won: the definitions
Everything ends up in one clause of the SPA, the sale and purchase agreement: the definitions of “Debt”, “Cash” and “Debt-like”. The price mechanism, locked box on a past balance sheet or completion accounts on actual figures after closing, comes after, and neither protects you from a badly written definition. The definition comes before the mechanism, and the mechanism before the multiple, even if at the table the discussion runs in the opposite order.
Translated into three moves: ask which schedule the net debt was calculated with; agree the list of debt-like items before you talk about the multiple; bring the twelve-month average net debt yourself.
The easy number and the number that counts
I went back to university at 41 partly for this: to give a precise name to things I had learned at my own expense, without knowing they had a paragraph in an ESMA document. The lesson is that the number you understand at the bar is almost always the easy part, and the easy part is rarely where the value is. The value is in the perimeter, in row K, in the month of March nobody looks at: it is boring, and precisely because of that, whoever reads it has an advantage that lasts. How many important decisions are you making by looking at the multiple, and how many by looking at the perimeter? And your net debt, the last time you saw it, was it the December one or the real one?
Sources: ESMA32-382-1138, Guideline 39, par. 175-189; CONSOB, warning notice 5/21; art. 2424 of the Italian Civil Code. This is not legal or tax advice: on a real deal the definitions are written by a professional with the contract in front of them.
