Business Activities
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• Reformulated balance sheet
– Published balance sheets list assets and liabilities,
usually classified into current and long-term
categories
• This division is useful for credit analysis
• For equity analysis, it is more useful to reformulate the
balance sheet into operating and financial assets and
operating and financial liabilities
– Operating assets and liabilities : assets and liabilities used in
the business of selling to customers; involves customers and
suppliers
– Financing assets and liabilities : assets and liabilities used in
the financing of the business; involves trading in capital
markets
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Balance Sheet
Assets
Liabilities and Equity
Operating assets
OA
Operating liabilities
OL
Financial assets
FA
Financial obligations
FO
Common stockholders’ equity
CSE
Total assets
OA+FA
Total claims
OL+FO+ CSE
Reformulated Balance Sheet
Operating Assets
Financial Obligations and Owners’ Equity
Operating assets
OA
Financial obligations
FO
Operating liabilities
(OL)
Financial assets
(FA)
Net financial obligations
NFO
Common stockholders’ equity
CSE
Net operating assets
NOA
Total claims
NFO+ CSE
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Reformulated Balance Sheet
Assets
Liabilities and Stockholders’ Equity
Financial assets:
Financial liabilities:
Cash equivalents
Short-term borrowings
Short-term investments
Current maturities of long-term debt
Short-term notes receivable
Short-term notes payable
Long-term debt investments
Long-term borrowing (bank loans, bonds
payable, notes payable)
Lease obligations
Preferred stock
Operating assets:
All else
Operating liabilities:
All else
Minority (noncontroling) interest
Common equity
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Net operating assets (NOA) = OA – OL
– NOA also sometimes referred to as enterprise
assets
If FA > FO:
Net financial assets (NFA) = FA – FO
Common shareholders’ equity (CSE) = NOA + NFA
Usually FA < FO:
Net financial obligations(NFO) = – NFA
Common shareholders’ equity (CSE) = NOA – NFO
– NFA/NFO also sometimes referred to as net debt
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• Reformulated income statement
– The income statement reports profits and losses
that NOA and NFA have produced over a given
period
– The reformulated statement groups these items
into operating and financing categories
• Includes dirty-surplus items from the statement of
shareholders’ equity
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Reformulated Income Statement
Operating revenue
OR
Operating expense
(OE)
Operating income
OI
Financial expense
XX
Financial income
(XX)
Comprehensive income
(NFE)
CI
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Reformulated Comprehensive Income Statement
Net sales
- Expenses to generate sales
Operating income from sales (before tax)
- Tax on operating income from sales
(4)
Operating income from sales after tax
+/- Other operating income (expense) requiring tax allocation
(1)
- Tax on other operating income
+/- After-tax operating items
(3)
Operating income (after tax)
- Net financial expenses after tax
(2)
- Minority interest
= Comprehensive income to common shareholders
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(1) Other operating income (expense) requiring tax allocation
Restructuring charges
Asset impairments
Merger expenses
Gains and losses on asset sales
Gains and losses on security transactions
• Taxes have to be calculated on these items
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(2) Net financial expenses after tax
+ Interest expense
- Interest revenue
+/- Realized gains and losses on financial assets
Taxes have to be calculated
on these items
= Net taxable financial expense before tax
- Tax benefit from net financial expenses
= Net taxable financial expenses after tax
+/- Gains and losses on debt retirement
+/- Dirty-surplus financial items
+/- Hidden dirty-surplus financing items
Will come from
reformulated shareholders’
equity
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(3) After-tax operating items
Equity share in subsidiary income
Operating items in extraordinary income
Dirty-surplus operating items
Hidden dirty-surplus operating items
• These items are already after-tax
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(4) Tax on operating income from sales
+ Tax as reported
+ Tax benefit from net financial
expenses
 Will come from (2)
- Tax allocated to other operating
income
 Will come from (1)
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• Reformulated statement of shareholders’
equity
– The statement of owners’ equity gives the
reconciliation of beginning and ending owners’
equity
– The reformulated statement groups these items
into (1) transactions with shareholders and (2)
comprehensive income
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Reformulated Statement of Common Shareholders’ Equity
Beginning book value of common equity
+ Net effect of transactions with common shareholders
+ Capital contributions (share issues)
- Share repurchases
- Dividends
= Net cash contribution (negative net dividends)
+ Effect of operations and non-equity financing
+ Net income (from income statement)
+ Other comprehensive income
- Preferred dividends
= Comprehensive income available to common shareholders
Closing book value of common equity
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• Beginning/Closing book value of common
equity must be adjusted for:
 (-) preferred stock, unless it is reported outside
of shareholders’ equity, such as redeemable
preferred stock
 (-) noncontrolling (or minority) interests
 (+) dividends payable
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• Comprehensive income = Net income + other
comprehensive income
– Other comprehensive income arises because of dirty
surplus accounting
• Dirty surplus accounting is the practice of reporting income
items in the statement of shareholders’ equity rather than in
the income statement.
• Dirty surplus items are unrealized gains and losses in assets
and/or liabilities due to changes in market prices
–
–
–
–
Unrealized gains and losses on securities available for sale
Foreign currency translation gains and losses
Gains and losses on derivative instruments
Changes in assets and liabilities due to pensions and
postemployment benefits
• All dirty surplus income items are reported on an after-tax
basis
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Dirty surplus items
Operating income items
Changes in accounting for contingencies
Additional minimum pension liability
Tax benefits of loss carryforwards acquired
Tax benefits of dividends paid to ESOPs
Unrealized gains and losses on equity securities available for sale
Foreign currency translation gains and losses
Gains and losses on derivative instruments designated as cash flow hedges
Some adjustments of deferred tax valuation allowances
Change in funding status of pension plans
Restatement of prior years’ income due to a change in accounting principles
Financing income (or expense) items
Preferred dividends
Unrealized gains and losses on debt securities available for sale
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