Reformulating financial statements: do people actually do this?
I've been reading a few financial textbooks and articles and many recommend restating GAAP financials to "better" reflect the realities of the business and allow readers to more efficiently and accurately interpret how the company is performing. For example, breaking the balance sheet out into operating assets / liabilities and financial assets / liabilities. Or, changing the cash flow statement to remove financing activities (like interest expense) from cash flow from operations, removing purchases of debt / equity instruments from CF from investing (and moving it to CF from financing), etc.
It all sounds persuasive but does anyone, whether in ER or HFs, ever bother to do this? Is it just too time consuming? And if not, how do you think about the issues that the textbooks and articles raise?
Thanks!
Yes, it is standard practice to adjust financial statements to better reflect the operations of the business. On a base level you should adjust for non-operating items on the income statement (gains/losses on asset sales, impairments, foreign exchange effects, etc) to look at how the base business performed ex these non-recurring effects.
The point of doing all this is that there is a lot of "noise" in GAAP numbers and you want to look at what the core business operations contributed, since that is where future income will be generated.
so is it the analysts responsibilities to reformat the statements? I recall once when i was a freshmen (4 years ago), that a family friend who's an analyst used to "yell at the accountants for not getting the numbers right." Not sure what this meant? He was in BB M&A then again.
Thanks rjroberts. I agree that extraordinary items in the income statement should be zeroed out, particularly given that almost all valuation is done on an EV/EBITDA or P/E basis.
The reformulation I was more thinking of is taking it a few steps further, such as changing the balance sheet so that instead of having it organized by time (i.e. current assets top left, longer-term assets bottom left, corresponding breakdown on liabilities side), some advocate showing operating assets on the top left and financial assets on the bottom left. Or for the cash flow statement, moving the purchase/sale of financial instruments to cash flow from investing. I can imagine this is less useful if we are just taking earnings and multiplying it by some capitalization factor but I think it helps think about the business.
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