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Slide 1Slide 2Slide 3Slide 4Slide 5Slide 6Slide 7Slide 8Slide 9Slide 10Slide 11Slide 12Slide 13Slide 14Slide 15Slide 16Slide 17Slide 18Slide 19Slide 20Slide 21Slide 22Slide 23Slide 24Slide 25Slide 26Slide 27Slide 28Slide 29Slide 30Slide 31Slide 32Slide 33Slide 34Slide 35Slide 36Slide 37Slide 38Slide 39Slide 40Copyright © 2009 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/IrwinFinancial Statement AnalysisK R SubramanyamJohn J Wild6-26CHAPTERAnalyzing Operating Activities6-3Economic IncomeEquals net cash flows + the change in the present value of future cash flowsIncludes both recurring and nonrecurring components—rendering it less useful for forecasting future earnings potentialPermanent IncomeAlso called sustainable earning power, or sustainable or normalized earningsEstimate of stable average income that a company is expected to earn over its lifeReflects a long-term focusDirectly proportional to company value Economic IncomeEquals net cash flows + the change in the present value of future cash flowsIncludes both recurring and nonrecurring components—rendering it less useful for forecasting future earnings potentialPermanent IncomeAlso called sustainable earning power, or sustainable or normalized earningsEstimate of stable average income that a company is expected to earn over its lifeReflects a long-term focusDirectly proportional to company value Income Measurement Concepts of Income6-4 Based on accrual accounting Suffers from measurement error, arising because of accounting distortionsAccounting Income consists of: Permanent Component--the recurring component expected to persist indefinitely Transitory Component--the transitory (or non-recurring) component not expected to persist (Note: The concept of economic income includes both permanent and transitory components.) Value Irrelevant Component--value irrelevant components have no economic content; they are accounting distortions  Based on accrual accounting Suffers from measurement error, arising because of accounting distortionsAccounting Income consists of: Permanent Component--the recurring component expected to persist indefinitely Transitory Component--the transitory (or non-recurring) component not expected to persist (Note: The concept of economic income includes both permanent and transitory components.) Value Irrelevant Component--value irrelevant components have no economic content; they are accounting distortions Income Measurement Concepts6-5Income Measurement MeasurementTwo main components of accounting income:Revenues (gains)Expenses (losses)6-6Revenues and Gains• Revenues are earned inflows or prospective inflows of cash from operations*• Gains are recognized inflows or prospective inflows of cash from non-operations** * Revenues are expected to recur**Gains are non-recurringIncome Measurement Measurement6-7Expenses and Losses•Expenses are incurred outflows, prospective outflows, or allocations of past outflows of cash from operations•Losses are decreases in a company’s net assets arising from non-operations Expenses and losses are resources consumed, spent, or lost in pursuing revenues and gains Income Measurement Measurement6-8Two major income dimensions:1. operating versus non-operating2. recurring versus non-recurring* *Motivated by need to separate permanent and transitory components Income Measurement Alternatives6-9Alternative Income Statement Measures• Net income—widely regarded as “bottom line” measure of income• Comprehensive income--includes most changes to equity that result from non-owner sources; it is actually the bottom line measure of income; is the accountant’s proxy for economic income• Continuing income--excludes extraordinary items, cumulative effects of accounting changes, and the effects of discontinued operations from net income* • Core income--excludes all non-recurring items from net income*Often erroneously referred to as “operating income” Income Measurement Alternatives6-10Income Measurement AnalysisOperating versus Non-Operating Income Operating income--measure of company income as generated from operating activities Three important aspects of operating income Pertains only to income generated from operations  Focuses on income for the company, not simply for equity holders (means financing revenues and expenses are excluded) Pertains only to ongoing business activities (i.e., results from discontinued operations is excluded) Non-operating income--includes all components of net income excluded from operating income Useful to separate non-operating components pertaining to financing and investing Operating versus Non-Operating Income Operating income--measure of company income as generated from operating activities Three important aspects of operating income Pertains only to income generated from operations  Focuses on income for the company, not simply for equity holders (means financing revenues and expenses are excluded) Pertains only to ongoing business activities (i.e., results from discontinued operations is excluded) Non-operating income--includes all components of net income excluded from operating income Useful to separate non-operating components pertaining to financing and investing6-11Income Measurement AnalysisDetermination of Comprehensive Income—sample company Determination of Comprehensive Income—sample company Net income Other comprehensive income:+/- Unrealized holding gain or loss on marketable securities+/- Foreign currency translation adjustment+/- Postretirement benefits adjustment+/- Unrealized holding gain or loss on derivative instrumentsComprehensive income6-12Non-Recurring ItemsExtraordinary itemsDiscontinued segmentsAccounting changesRestructuring chargesSpecial items6-13Non-Recurring Items Extraordinary ItemsCriteriaUnusual in natureInfrequent in occurrenceExamplesUninsured losses from a major casualty (earthquake,hurricane, tornado), losses from expropriation, and gains and losses from early retirement of debtDisclosure & AccountingClassified separately in income statementExcluded when computing permanent income Included when computing economic incomeCriteriaUnusual in natureInfrequent in occurrenceExamplesUninsured losses from a major casualty (earthquake,hurricane, tornado), losses from expropriation, and gains and losses from early


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OSU BA 435 - Financial Statement Analysis

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