Lesson 4 of 8 · 12 min
Capitalised interest and capitalised development costs
Interest and development costs can sit on the balance sheet instead of the income statement, so analysts add them back to get true interest coverage and comparable profit, cash flow and valuation multiples.
In short
- Interest on assets that take a long time to build is capitalised: into the asset's cost (expensed later as depreciation) or, for assets built for sale, into inventory (expensed later as cost of sales).
- Capitalised interest is an investing outflow; expensed interest is operating (US GAAP) or operating or financing (IFRS).
- For true interest coverage, divide EBIT (plus depreciation of previously capitalised interest) by total interest, including the capitalised amount.
- Software development costs are capitalised once technological feasibility is established; judgement makes practice vary widely.
- To compare a capitaliser with an expenser: expense current development spending, remove amortisation of past capitalised costs, cut operating cash flow by the spending, and recompute ratios such as P/E, P/CFO and EV/EBITDA.
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