Above the line / Below the line (Operating vs.

Nonoperating expenses)

Income and expenses that occur as a result of a company's major or central operations" are classified as operating items. Items such as Revenues, COGS, SG&A, D&A fall under this category and are reported above the EBIT line (termed simply "above the line"). Income and expenses from peripheral or incidental transactions (such as gains and losses from asset sales, lawsuits, changes in market valus, etc...) are classified as nonoperating items and are reported below the EBIT line (termed simply "below the line"). Analysts tend to focus on a company's operating metrics (above the line) such as EBIT and EBITDA in an effort to better assess a company's ongoing growth prospects without the "noise" of nonoperating results that get included in net income. A company's obligations to suppliers for services and products already purchased from them, but which have not been paid. In other words, accounts payable represent the company's unpaid bills to its suppliers for services obtained on credit from them. Payment owed to a business by its customers for products and services already delivered to them. Represents capital received by a company when its shares are sold above their par value. Disposal of fixed assets (cash inflow). Asset turnover = Net sales / Average total assets and is a measure of efficiency of a company's assets in generating sales. Organic expansion of fixed assets (cash outflow). The Cash Flows from Operations section of the cash flow statement tracks cash movement associated with the company's daily on-going activities. Working capital changes from one quarter to the next (or one year to the next) have a corresponding cash impact. When working capital assets increase, the cash impact is negative. Conversely, when working capital liabilities increase, the cash impact is positive. Cost of Goods Sold period 1 = Inventorybeginning of period 1 - Inventoryend of period 1 Cost of Goods sold represents a company's direct cost of manufacture (for manufacturers) or procurement (for merchandisers) of a good or service that the company sells to generate revenue. Raw material costs, direct factory labor, delivery costs, and any other costs directly associated with the generation of revenue are include in this line item. On the other hand, costs such as administration and marketing cannot be directly attributed to producing the product and are thus not included in Cost of Goods Sold (they are included under Selling, General, & Administrative costs instead). Assets that are expected to be converted into cash within 12 months. Current liabilities are to be paid within 12 months.

Accounts Payable

Accounts Receivable Additional Paid-In Capital (APIC) Asset Sales Asset Turnover

Capital Expenditures Cash Flow from Operations Changes in Working Capital

Cost of Goods Sold (COGS/CGS)

Current Assets Current Liabilities

Current Ratio

Current ratio = current assets / current liabilities and is a measure of a company's short-term debtpaying ability.

Degree of Operating Leverage (DOL) Degree of operating leverage = % change in EBIT / % change in Sales and is a measure of the riskiness of a firm's operations independent of financial leverage. Depreciation and Amortization Depreciation The "systematic and rational allocation of the cost of property, plant, and equipment (PP&E) Expense (D&A) other than land to future years in whch these assets contribute services to help generate revenue." In other words, when a company acquires an asset that is expected to generate benefits over future periods (such as a manufacturing facility, an airplane, or a conveyer belt), the cost of that asset is not simply recognized on the year it was acquired. Rather, the cost is allocated over that particular asset's useful life in order to match the timing of the cost of the asset with when it is expected to generate revenue benefits (recall that under the matching principal of accounting requires that expenses (costs) are matched to the period in which revenue is earned as a result of using the asset). Example If a company spends $40 million in 2004 to acquire a manufacturing plant that is expected to be productive for the next 20 years (assuming no salvage value for now), the company will not simply expense the $40 million that it spent on the plant in 2004, rather it will record the acquistion under PP&E on the balance sheet and allocate and expense part of that $40 million each year over the next 20 years on the income statement. Should the company decide to allocate the expense equally over the plant's 20 year useful life (called straight-line depreciation), it would be $40m/20year = $2m/year. This annual expense is called depreciation expense. It is sometimes represented on the income statement within Cost of Goods Sold, but is more often represented as a separate line item, "Deprecation and Amortization." Balance Sheet Impact The corresponding impact on the balance sheet of the annual $2m depreciation expense recoded on the income satement is a $2 million annual reduction of the PP&E balance . Thus, after 20 years, when the entire $40m has been depreciated, the remaining value of the plant (called book, or carrying value) is $0, reflecting that the plant has been, essentally, used up. The book or carrying value is defined as the acquistion cost of the PP&E asset ($40m in this example) less the accumulated depreciation (the sum of depreciation expense) from the acquisition date to the date of the balance sheet under review. Amortization Conceptually identical to depreciation, amortization is the "systematic and rational allocation of the acquistion cost of intangble assets to future years in whch these assets contribute help generate revenue." Unlike PP&E, however, Intangible assets recorded on the balance sheet represent assets that cannot be physically touched, such as a goodwill, brand, franchise, trademark, or patent. opposite of tangible asset. By far the most frequently reported intangible asset is goodwill. With the important exception of goodwll, the acquistion cost of intangible assets such as patents, deferred financing and brands, are treated on the income statement very similarly to the acquistion cost of PP&E: it is not simply expensed on the year it is acquired. Rather, the cost is allocated over the useful life of the intangible assets in order to match the timing of the cost of

the intagible asset with when it is expected to generate revenue benefits. The annual expense this creates on the income statement is called amortization expense. Dividends DuPont Analysis Regular distribution of cash (cash outflow) to the company's shareholders. DuPont Analysis = Profitability x Activity x Solvency = (Net income / Sales) x (Sales / Assets) x (Assets / Equity). The ratio allows the analysis of three components of return on equity (ROE): Net margin, Asset Turnover, and Leverage factor. An indicator of a company's financial performance calculated as EBIT - Interest Expense (net of interest income) An income statement measure of a company's profitability calculated as revenue minus expenses excluding tax and interest. EBIT is also referred to as operating earnings. Example: Revenues Cost of Goods Sold (CGS) Selling, General & Administrative (SG&A) Other Expenses EBITDA Depreciation & Amortization EBIT (Rev - CGS - SG&A - D&A) Interest Expense EBT Income Taxes (30% tax rate) Net Income EBITDA Earnings Before Interest, Taxes, Depreciation, and Amortization

EBT (Pretax Income) EBIT (Operating Earnings)

100.0 20.0 10.0 7.0 63.0 5.0 58.0 15.0 43.0 12.9 30.1

A popular measure of a company's financial performance calculated as revenue minus expenses excluding taxes, interest expense, and depreciation & amortization:

Example: Revenues Cost of Goods Sold (CGS) Selling, General & Administrative (SG&A) Other Expenses EBITDA (Revs - CGS - SG&A - Other) Depreciation & Amortization EBIT (Rev - CGS - SG&A - D&A)

100.0 20.0 10.0 7.0 63.0 5.0 58.0

Interest Expense EBT Income Taxes (30% tax rate) Net Income

15.0 43.0 12.9 30.1

EBITDA can be used to analyze the profitability between companies and industries, because it eliminates the effects of financing and accounting decisions. A common misconception is that EBITDA represents cash earnings. EBITDA is good metric to evaluate profitability, but not cash flow. EBITDA first came into common use with leveraged buyouts in the '80s, where it was used to indicate the ability of a company to service debt. As time passed, it became popular in industries with expensive assets that had to be written down over long periods of time. EBITDA is now commonly quoted by many companies, especially in the technology sector, even when it isn't warranted. Consequently, EBITDA is being used as an accounting gimmick to dress up a company's earnings. EPS (Earnings Per Share) The portion of a company's profit allocated to each outstanding share of common stock. Calculated as net income less dividends from preferred stock divided by average shares outstanding. EPS is the single most popular variable in dictating a share's price. EPS indicates the profitability of a company

Example: Revenues Cost of Goods Sold (CGS) Selling, General & Administrative (SG&A) Other Expenses EBITDA (Revs - CGS - SG&A - Other) Depreciation & Amortization EBIT (Rev - CGS - SG&A - D&A) Interest Expense EBT Income Taxes (30% tax rate) Net Income Dividends on Preferred Stock Average Outstanding Shares (mm)* Average Diluted Outstanding Shares (mm)** Basic EPS = Net Income - Divs on Pref. Stock Avg. Outstanding Shares

100.0 20.0 10.0 7.0 63.0 5.0 58.0 15.0 43.0 12.9 30.1 2.1 11.2 14.0 $2.50

Diluted EPS** = Net Income - Divs on Pref. Stock $2.00 Avg. Diluted Outstanding Shares * Companies usually use a weighted average number of shares outstanding over the reporting term. **The diluted shares and diluted EPS means that the outstanding shares in the clculation include any convertibles or warrants outstanding.

Equity in affiliates

When a company has an influential but noncontrolling investment in another company (typically between 20%-50% ownership), it will account for its ownership as "Equity in affiliates" on the income statement. As an illustration, if our company A owns, say, 20% of company B, and coppany B reported net income of $10m and dividends of $2m, company A will record the following in this line item: Equity in affiliates = 20% * ($10m-2m) = 20% * $8m = $1.6m External liquidity (marketability) ratios measure the number of securities traded per day, bid/ask spread (%) , and percentage of outstanding securities traded per day in order to determine the ability to quickly purchase a company's shares. After-tax net income plus depreciation and amortization, deferred taxes and other non-cash charges less capital expenditures and increase in working capital investment. Free cash flow (FCF) is an important measure of the company's ability, following its daily obligations (working capital) and investment requirements (capital expenditures), to service debt. Gain (losses) on asset sales: The gain (or loss) recorded from the sale of an asset. When a company sells an asset with a book value of $5 for $8, it records a gain on sale of $8 - $5 = $3. This gain (or loss) is reflected on the income statement as a nonoperating expense below the EBIT line (often termed simply "below the line"). Non-physical assets such as brands, patents, trademarks, and goodwill acquired by the company that have value based on the rights belonging to that company. Gross profit margin = (Net sales cost of goods sold) / Net sales and is a measure of the relationship between sales and manufacturing/merchandising costs. Growth analysis ratios measure growth rates from one period to the next or over a certain period (such as Compound Annual Growth Rate = CAGR). Financial report that summarizes the revenues and expenses, and shows the net profit or loss in a specified accounting period. This statement depicts a business entity's financial performance due to operations as well as other gains or losses. The income statement is also known as the Profit and Loss Statement or Statement of Revenue and Expense, it is the portion of the financial statement that is analyzed the most. It shows the

External Liquidity

Free Cash Flow

Gains (losses) on asset sales

Goodwill & Intangibles

Gross Profit Margin

Growth Analysis

Income Statement (P&L)

ability of a company to assure success for both the company and its shareholders through the earnings from operations. Interest Coverage Interest Expense Interest coverage = EBIT / Interest expense and measures the quality of a firm's bonds. Interest expense is the amount the company has to pay on debt owed. This could be to bondholders or to banks. Interest expense subtracted from EBIT equals net earnings. Example: Revenues Cost of Goods Sold (CGS) Selling, General & Administrative (SG&A) Other Expenses EBITDA Depreciation & Amortization EBIT Interest Expense EBT Income Taxes (30% tax rate) Net Income

100.0 20.0 10.0 7.0 63.0 5.0 58.0 15.0 43.0 12.9 30.1

Interest Income

A company's income from its cash holdings and investments (stocks, bonds, and savings accounts). Inventories represent any unfinished or finished goods that are waiting to be sold, and the direct costs associated with the production of these goods. Inventory turnover = Cost of goods sold / Average inventory and is a measure of liquidity of inventories. The company's borrowings with a maturity (full repayment) exceeding 12 months. Simply the inverse of Equity in Affiliates: if company B has a significant, but non-controlling, outside ownership interest in our company A, then we must subtract that interest from net income (after all, its income that doesnt belong to us, rather it belongs to company B). Net assets equal assets minus liabilities and are used as a proxy for fair market value (FMV) of a firm during a transaction (acquisition, LBO). Net Debt equals: Short-Term Debt + Long-Term Debt (including current portion) + Minority Interest + Preferred Stock + Capitalized Leases (Cash + Cash Equivalents). Net debt plus equity

Inventories

Inventory Turnover

Long-Term Debt Minority Interest

Net Assets

Net Debt

(market) value of a company make up its enterprise value i.e. the value of all capital invested in the business. Net Income (Net Earnings) See Also: EBIT (Operating Earnings), Net Operating Income (NOPAT), EPS An individual or company's total earnings, reflecting revenues adjusted for costs of doing business, depreciation, interest, taxes, and other expenses. Example: Revenues Cost of Goods Sold (CGS) Selling, General & Administrative (SG&A) Other Expenses EBITDA Depreciation & Amortization EBIT Interest Expense EBT Income Taxes (30% tax rate) Net Income

100.0 20.0 10.0 7.0 63.0 5.0 58.0 15.0 43.0 12.9 30.1

Net Increase / Decrease in Cash

Net increase/decrease in cash represents the cash inflow (outflow) from one period (quarter or year) to the next, stemming from the company's operating, investing, and financing activities. The change in cash reflected on the cash flow statement must always equal the change in cash reported on the balance sheet between two periods. A company's operating income minus income taxes and minority interest. NOI is often viewed as a good measure of company performance. Some believe this figure is less susceptible to manipulation by management. Operating profit margin = Earnings before interest & taxes (EBIT) / Net Sales and is a measure of a company's profitability from its "recurring" operations, before the effect of financing (interest expense) and taxes. Any operating expenses not classified under COGS, SG&A, or D&A. Management retains some discretion with respect to how various operating expenses are classified. One operating expense of note is Research and Development (R&D), which represents a company's activities that are directed at developing new products or procedures. Although R&D is identified here under 'Other Operating Expenses", corporations operating in research-intensive industries such as healthcare and technology often identify R&D separately because the expense is such a large component of total expenses. In 2003, Pfizer, one of the world's largest pharmaceutical companies, reinvested nearly xxx% of the total gross profit back into R&D.

Net Operating Income (NOPAT)

Operating Profit Margin

Other Operating Expenses

Other Nonoperating Income (Expenses) PP&E Research and Development (R&D) Receivables Turnover

Income and expenses from peripheral or incidental transactions (such as lawsuits, changes in market valus, etc...) Land, buildings, and machinery used in the manufacture of the company's services and products. See Other Operating Expenses Receivables turnover = Net sales / Average accounts receivable and serves as a measure of liquidity of receivables. Return on common equity = Net income to common stockholders / Average common stockholders' equity and is a measure of profitability of shareholders' investment. Return on total capital = Earnings before interest & taxes (EBIT) / Average (Total Debt + Stockholders' Equity) and is a measure of profitability for all capital providers. Total dollar payment for goods and services that are credited to an income statement over a particular time period. Revenue figures will usually be net of discounts or any payments that are returned to the customer or client. By subtracting expenses from revenue, a company's net income can be calculated. In terms of reporting revenue in a company's financial statements, the question of when revenue should be considered received (or "recognized") is sometimes not clear. For example, revenue could be recognized when the deal is signed, when the money is received, when the services are provided, or at other times. There are rules specifying when revenue should be recognized in different situations, and in general, companies should recognize revenue only when the good or service is fully transferred over to the customer/client, and when the amount of revenue to be received can be reliably determined. Example: Revenues Cost of Goods Sold (CGS) Selling, General & Administrative (SG&A) Other Expenses EBITDA Depreciation & Amortization EBIT Interest Expense EBT Income Taxes (30% tax rate)

Return on Common Equity

Return on Total Capital

Revenue (Sales)

100.0 20.0 10.0 7.0 63.0 5.0 58.0 15.0 43.0 12.9

Net Income Retained Earnings Selling, General, & Adminitrative Costs (SG&A)

30.1

Total amount of earnings of a company since its inception minus dividends and losses (if any). SG&A expenses consist of the operating costs not directly associated with the production or procurement of the product or service that the company sells to generate revenue. Payroll, wages, commissions, meal and travel expenses, stationary, advertising, and marketing expenses fall under this line item. Represents a major source of funds for the company via: 1.) Issuance of equity, and 2.) On-going operations. Borrowings owed by the company that are due within 1 year. The tax liability a company reports on the income statement Total assets represent all of the company's owned and quantifiable resources. Total debt ratio = Total debt / (Total liabilities + capital) and measures the percentage of a company's assets that are financed with debt. Total liabilities represent all of the company's measurable and likely-occurring obligations. Common stock that had been issued and then reacquired (bought back) by a company. Working capital, calculated as current assets less current liabilities, is an important measure of a company's ability to cover day-to-day operating activities.

Shareholders' Equity

Short-Term Debt Taxes (Income Tax Expense) Total Assets Total Debt Ratio

Total Liabilities Treasury Stock Working Capital