What are the best practices for accounting minority interests in a financial model?

1 What are minority interests?

Minority interests arise when a parent company acquires less than 100% of the equity in a subsidiary. For example, if Company A buys 80% of Company B for $100 million, the remaining 20% of Company B is the minority interest. The parent company has to consolidate the financial statements of the subsidiary, but also report the minority interest separately on the balance sheet and the income statement. The minority interest reflects the share of the subsidiary's net assets and net income that belongs to the minority shareholders.

2 How to calculate minority interests?

To calculate the minority interest on the balance sheet, you need to multiply the percentage of the subsidiary that is not owned by the parent by the book value of the subsidiary's net assets. For example, if Company B has $50 million of net assets, the minority interest on the balance sheet is 20% x $50 million = $10 million. To calculate the minority interest on the income statement, you need to multiply the percentage of the subsidiary that is not owned by the parent by the net income of the subsidiary. For example, if Company B has $10 million of net income, the minority interest on the income statement is 20% x $10 million = $2 million.

3 How to account for minority interests in a financial model?

To account for minority interests in a financial model, you need to create a separate worksheet for the subsidiary's financial statements and link it to the parent's worksheet. Additionally, adjust the parent's revenue and expenses to include the subsidiary's revenue and expenses, and add a line item for minority interest expense below EBIT. Similarly, adjust the parent's assets and liabilities to include the subsidiary's assets and liabilities, and add a line item for minority interest liability below equity. Moreover, adjust the parent's cash flow statement to include the subsidiary's cash flows, and subtract the minority interest expense from net income to get cash flow from operations. Finally, adjust the parent's valuation metrics to include the subsidiary's valuation metrics, and subtract the minority interest liability from enterprise value to get equity value.

4 What are the common pitfalls and errors?

When accounting for minority interests in a financial model, it is important to avoid common pitfalls and errors. This includes using the wrong percentage of ownership, which should be the percentage of the subsidiary that is not owned by the parent, not the percentage that is owned by the parent. Additionally, the book value of the subsidiary's net assets should be used to calculate the minority interest on the balance sheet, not the market value or purchase price. Furthermore, you should not include the subsidiary's cash flows in the parent's free cash flow as they are already reflected in the minority interest expense and liability. Moreover, you should account for the tax effects of the subsidiary's income and expenses, and the parent's acquisition and divestiture of the subsidiary, on the parent's tax expense and deferred tax assets and liabilities. Lastly, it is essential to update assumptions for the subsidiary's growth, margins, capital structure, and cost of capital as they may differ from those of the parent.

5 Why are minority interests important?

Accounting for minority interests in a financial model is important for several reasons. It accurately reflects the true economic ownership and performance of the parent and the subsidiary, allowing for a more accurate valuation and analysis. Additionally, it helps to identify potential synergies and risks from the acquisition or divestiture of the subsidiary, as well as evaluate the strategic rationale and returns of the deal. Moreover, it complies with accounting standards and regulations, thus enhancing the credibility and transparency of the financial statements and the model.

6 Here’s what else to consider

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