Adjusting a Company's Reported Financial Statements

  • At the core of financial analysis is the ability of an analyst to revise a company's reported financial statements in order to create a "true" economic picture of performance and financial positions.

  • In this article, we will look at:

  • Balance Sheet: Common Analyst Adjustments

  • Income Statement: Common Analyst Adjustments

  • Statement of Cash Flows: Common Analyst Adjustments

Balance Sheet: Common Analyst Adjustments (not exhaustive)

  • Create an approximate fair market value of inventory by restating LIFO inventories to FIFO on the balance sheet.
  • When available data permits, restate the balance sheet's historic value of property, plant, and equipment to fair market value.
  • Attempt to estimate the value of a company's intangible assets. Note that some analysts eliminate goodwill on the asset side of the balance sheet altogether and make the corresponding reduction to retained earnings in the equity segment of the balance sheet.
  • Revalue company liabilities to their fair market value by using current interest rates to determine the present value of future cash flows needed to service the liabilities.
  • Move off-balance sheet liabilities, such as operating leases, onto the balance sheet.

Income Statement: Common Analyst Adjustments (not exhaustive)

  • Remove non-recurring items from current year evaluation, but incorporate them if evaluation of multi-year trends.
  • Make the necessary adjustments to account for different accounting methodologies or estimates when comparing multiple firms.
  • Adjust net income to include direct to equity gains and losses that are captured as part of other comprehensive income.
  • Apply LIFO expensing method (if company does not already employ the LIFO method) for calculating cost of goods sold.

Statement of Cash Flows: Common Analyst Adjustments (not exhaustive)

  • Isolate and remove cash flows from non-recurring items as these cash flows are not likely to be generated by the company in future periods.
  • When looking at investing cash flows, separate capital expenditure cash flows from other investing cash flows.
  • Transfer cash interest and dividend income received from operating cash inflows to investing cash inflows.
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