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Most companies benefit from R&D spending in the form of acquired know-how. This acquired know-how is a valuable asset that produces cash flow in the future. Analysts and investors should want the value of R&D spending in the balance sheet. So R&D should be treated like another investment and the R&D spending capitalized like other assets such as an investment in a building.
How does capitalizing R&D expenses impact the cash flow statements?
Companies can either buy or lease assets it needs on a long-term basis. For example, a firm can buy a truck required for the business or lease the truck. A company usually leases a long-term asset if it either 1) does not have the money to buy it and 2) does not want to borrow the capital required to buy these assets. The business case should be the driver of this decision. Sometimes, companies may lease the asset because it does not have money to buy the asset or wants to avoid taking on more debt. Accounting rules specify the conditions required to treat an operating lease as a capital lease and capitalize it.
What impact does capitalizing an operating lease have on the balance sheet? We address this question here with a live Microsoft Excel model.
We have shown below the impact of capitalizing an operating lease on a company’s financial statements. Note that the financial statements on the left side are statements before any adjustment is done. The financial statements on the right side are the financial statements after the operating lease capitalization adjustments are done.
The value of any asset is equal to the present value of all future cash flow is the concept being relied on when valuing a firm using the DCF valuation method. Does the interest rate factor in your model? If so, how does the interest rate factor in your model? There are at least two ways the interest rates are accounted for in a DCF valuation model.
We discuss the different ways interest rates can factor into your DCF valuation model on this page.