Business Activities

 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
Total assets

OA+FA

Total claims

CSE
OL+FO+
CSE

Reformulated Balance Sheet

Operating Assets
Operating assets
Operating liabilities

Net operating
assets

Financial Obligations and Owners

Equity
OA
(OL)

NOA

Financial obligations

FO

Financial assets

(FA)

Net financial obligations

NFO

Common stockholders
equity

CSE

Total claims

NFO+
3
CSE

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

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

Reformulated Income Statement

Operating revenue

OR

Operating expense

(OE)

Operating income

OI

Financial expense

XX

Financial income

(XX)

Comprehensive income

(NFE)
CI

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
- Minority interest
= Comprehensive income to common shareholders

(2
)
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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

(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

Will come from

reformulated
shareholders equity

+/- Gains and losses on debt

retirement
+/- Dirty-surplus financial items
+/- Hidden dirty-surplus financing
items

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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

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