Various Definitions of Earnings

There are a number of earnings definitions and CFAI expects candidates to know the differences among the various definitions and recognize adjustments which should be made to reported earnings in order to perform valuation analysis.

Operating Income (OI)

OI = Revenues - Cost of Goods Sold - Selling, General, & Admin Expenses - Other Operating Expenses

• In theory, OI represents profit from core business operations; however management may shift non-core gains into (or core losses out of) its OI reporting, in order to show better than actual core business performance.
• Depreciation and Amortization: this is a component of OI, but might not be explicitly called out on the income statement; in this case the analyst needs to refer to the statement of cash flows and/or the footnotes for details.
• Interest Expense & Interest Income: this is reported below the OI line.
• Unusual and Infrequent Items, such as employee severance pay as part of a restructuring are part of the OI calculation; in the U.S., extraordinary items are not included in the OI calculation.

Earnings Before Interest, Taxes, Depreciation & Amortization (EBITDA)

EBITDA = Net Income + Taxes + Interest + Depreciation & Amortization

Income Before Taxes (or Earnings Before Taxes-EBT)

EBT = Net Income + Provision for Income Taxes

• Analysts must be aware that applying this formula as stated may lead to the inclusion of discontinued operations, which are commonly eliminated when projecting a company's future earnings.

Income from Continuing Operations

• Under IFRS and GAAP, discontinued operations reflect a disposed or established plan of disposal for a business component in which there will be no future involvement. In order to qualify, the business component needs to have separately identifiable operations and assets.

Income before Extraordinary Items

• GAAP allows firms to classify certain events as extraordinary, reporting the item below continuing operations and net of tax. In order to qualify, the item must be both unusual and infrequent in nature. IFRS does not allow the classification of extraordinary items on the income statement.

Net Income

• "The bottom line", net income is the basis for calculating a firm's basic earnings per share and diluted earnings per share.