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Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 1
Profitability Analysis
Formatting and Adjusting The Income Statement
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 2
Companies use different presentation formats for their income statements.1 In addition, the accounting rules for the income statement do not always reflect comparability with prior years or forecasts or comparability with other firms. The analyst must select a single format to facilitate the comparison among companies. The analyst must adjust the income statement by:2 ˆ I. REFORMATTING ˆ II. RECLASSIFICATION3 I. A REFORMATTING places amounts from an income statement into one of five sections:
§ Operating: Sales & services less related expenses for operating a business but excluding financing income and expense4 § Non-Operating: Financial Income as a by-product of operating the business § Financial Cost, Gross § Tax Provision § Items Separated for Analysis [net of tax]:
o Equity Income and NonControlling Interest and o Items that Relate to More than One Year [net of tax]: gains & losses that relate to more than one year (or to a different year)5
II. A RECLASSIFICATION moves amounts from one line to another line without changing the “bottom line” (i.e., no change in retained
earnings in the balance sheet or net income in the income statement). For an immaterial reclassification (or when an amount is unknown), the analyst may merely footnote the reported amounts. Reclassifying (sometimes called “recasting”) allows the analyst to:
o change the location of an item6 o combine two (or more) items to condense disclosure o separate one amount into two or more amounts for better disclosure
1Most companies prepare their balance sheets and statements of cash flows in formats that are comparable to other companies. Some financial institutions do use a common “spread sheet” so that all companies are identical in format. 2In most cases, the analyst will need to consider both (i) reported financial statements and (ii) analytically adjusted financial statements and must clearly identify any amounts and ratios as “reported” or ”adjusted" 3 Reclassification is the most common technique for the Income Statement 4 You will notice no subtotal for gross profit as this calculation doesn't get much prominance, especially in the credit world. 5e.g., cumulative effect of change in accounting on prior years; gain on disposal of PPE; gain (loss) from of discontinued operations; loss on early retirement of long-term debt; inventory holding gain recognized upon Lifo liquidation; other gains & losses that relate to more than one year., such as special charges, asset impairments, goodwill impairment, writedowns, restructuring reserves. S&P considers acquisition related charges, goodwill impairment, litigations, and gain and loss on the sale of assets as unusual. 6e.g., move a special charge (pretax) to segregated items (net of tax) at the bottom of the income statement.
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 3
Analytically Adjusted Income Statement—Form [AAIS] A common presentation format for the credit world is shown on the following pages. Procedure: Step 1. Make a copy of the income statement common format on the next two pages. Step 2. Enter each amount from the company’s statement into the attached format.
Suggestions: a. Show all expenses in brackets. Be careful because many companies are not consistent in their use of brackets within the income
statement and in the income taxes footnote. b. Start with the company’s presentation. If analytical changes are necessary to move items to a different section of the income
statement, use a separate “changes” column. Step 3. Calculate sub-totals.
Barry M Frohlinger
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 4
Income statement Reported 1 2 3 4 5 6 Recurring
1 Sales
2 COGS
3 Selling, general, and administrative costs
4 Other operating expenses
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit
8 Interest income
9 Other non-operating income (expense)
10 Other non-operating income (expense)
11 Other non-operating income (expense)
12 = EBIT
13 Gross interest expense
14 = EBT
15 Total tax expense
16 = Income from continuing operations
17 Equity income
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items
21 = Net income
22 Depreciation
23 Amortization
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24]
26 Operating EBITDA [rows 7, 22, 23,24]
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 5
Income statement Reported 1 2 3 4 5 6 Recurring
1 Sales
2 COGS
3 Selling, general, and administrative costs
4 Other operating expenses
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit
8 Interest income
9 Other non-operating income (expense)
10 Other non-operating income (expense)
11 Other non-operating income (expense)
12 = EBIT
13 Gross interest expense
14 = EBT
15 Total tax expense
16 = Income from continuing operations
17 Equity income
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items
21 = Net income
22 Depreciation
23 Amortization
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24]
26 Operating EBITDA [rows 7, 22, 23,24]
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 6
Income statement Reported 1 2 3 4 5 6 Recurring
1 Sales
2 COGS
3 Selling, general, and administrative costs
4 Other operating expenses
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit
8 Interest income
9 Other non-operating income (expense)
10 Other non-operating income (expense)
11 Other non-operating income (expense)
12 = EBIT
13 Gross interest expense
14 = EBT
15 Total tax expense
16 = Income from continuing operations
17 Equity income
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items
21 = Net income
22 Depreciation
23 Amortization
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24]
26 Operating EBITDA [rows 7, 22, 23,24]
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 7
Income statement Reported 1 2 3 4 5 6 Recurring
1 Sales
2 COGS
3 Selling, general, and administrative costs
4 Other operating expenses
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit
8 Interest income
9 Other non-operating income (expense)
10 Other non-operating income (expense)
11 Other non-operating income (expense)
12 = EBIT
13 Gross interest expense
14 = EBT
15 Total tax expense
16 = Income from continuing operations
17 Equity income
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items
21 = Net income
22 Depreciation
23 Amortization
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24]
26 Operating EBITDA [rows 7, 22, 23,24]
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 8
Par Pharmaceutical
Par Pharmaceutical's 2019 financial statements are attached (footnotes have been omitted). Par and its subsidiary, Quad, market a comprehensive line of generic tablets, capsules and injectables and will introduce liquids, ointments, creams & lotions during fiscal 2020. DISCUSSION QUESTION: A. Complete a properly formatted income statement for both years.
a. [Use the attached form]. b. This exercise will help you understand the mechanics for formatting the income statement and
reclassifying [adjusting] the income statement. c. You will not be able to complete every line, just fill in the information that you have. d. You can consider the provision for litigation an unusual item, and reclassify it below the line. e. IGNORE INCOME TAX FOR THIS EXERCISE.
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 9
Consolidated Statements of Income and Retained Earnings
Year Ended
October 1. October 3. September 27. 2019 2018 2017
Net sales $ 99,548 $78,684 $39,357 Dividend, interest and other income 1,043 1,091 528 Total revenues 100,591 79,775 39,885 Costs and expenses: Cost of goods sold 48,593 38,599 20,223 Product development 6,546 4,065 2,828 Selling, general and administrative 21,102 15,633 7,812 Interest Expense 1,392 820 668 Provision for litigation 3,183 846____________ 80,816 59,963 31,531 Income before provision for income taxes 19,775 19,812 8,354 Provision for income taxes:
State 1,281 557 375 Federal 7,384 8,341 3,337 8,665 8,898 3,712
Net income 11,110 10,914 4,642 Cash dividend (221) Retained earnings, beginning of year 23,681 12,767 8,125 Retained earnings, end of year 34,570 23,681 12,767 Net income per share of Common Stock $.99 $.97 $.45 Weighted average number of common and common equivalent shares outstanding 11,246 11,237 10,226
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 10
Consolidated Balance Sheets
October 1, October 3,
2019 2018 ASSETS
Current Assets Cash and cash equivalents $ 5,903 $ 3,190 Temporary investments 4,556 17,454 Accounts receivable, net of allowance for doubtful accounts of $551 and $340 20,399 13,130 Inventories 18,666 13,805 Deferred tax benefit 2,424 1,244 Prepaid expenses and other current assets 798 1,053 Total current assets 52,746 49,876 Property, plant and equipment at cost Less accumulated depreciation and amortization 30,255 21,606 Restricted cash and investments 3,111 4,543 Deferred charges and other assets 3,842 2,122
$89,954 $78,147 LIABILITIES AND SHAREHOLDERS' EQUITY Current Liabilities Current portion of long-term debt $ 833 $ 686 Accounts payable 5,132 5,457 Salaries and employee benefits 4,774 3,063 Accrued expenses and other current liabilities 3,277 5,868 Income taxes 265 1,167 Total current liabilities 14,281 16,241 Long-term debt,less current portion 15,021 15,232 Deferred income taxes 1,606 1,161 Other 5,220 1,603 Commitments, contingencies and other matters Shareholders' equity: Common Stock, par value $.01 per share; authorized 30,000 shares; outstanding 11,030 and 11,043 shares 110 110 Additional paid-in capital 19,146 20,119 Retained earnings 34,570 23,681 Total shareholders' equity 53,826 43,910
$89,954 $78,147
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 11
Consolidated Statements of Cash Flows
Year Ended October 1. October 3. September 27. 2019 2018 2017
Cash flows from operating activities: Net income $11,110 $10,914 $ 4,642 Adjustments to reconcile net income to Net cash provided by operating activities Depreciation 2,050 1,200 990 Amortization 210 148 135 Deferred taxes (735) (1,959) 814 Provision for litigation 3,183 846 (145) Changes in assets and liabilities: Increase in accounts receivable (7,269) (3,557) (4,764) Increase in inventory (4,861) (5,405) (3,984) (Increase) decrease in prepaid expenses and other current assets 50 (273) (494) Increase (decrease) in accounts payable (478) 1,252 2,250 Increase (decrease) in accrued expenses and other current liabilities (916) 4,745 2,560 Increase (decrease) in income taxes payable (902) 1,039 557 Net cash provided by operating activities 1,441 8,826 2,561 Cash flows from investing activities: Capital expenditures (10,961) (7,916) (4,321) (Increase) decrease in restricted cash 1,469 (1,762) (2,576) (Increase) decrease in temporary investments 12,898 (14,489) 635 Purchase of minority interest in subsidiary (570) Purchase of other investments (650) Other (226) 175 (696) Net cash provided (used) by investing activities 2,530 (24,562) (6,958) Cash flows from financing activities: Sale of stock in public offering 12,313 Borrowings under long-term debt 6,734 9,010 7,227 Proceeds from issuance of note payable 2,100 Proceeds from issuance of capital stock 907 1,382 172 Payments of long-term debt (6,798) (4,463) (3,397) Payment of note payable (2,100) Purchase of capital stock (1,880) Cash dividend (221)_______________________ Net cash provided (used) by financing activities (1,258) 5,929 16,315 Net increase (decrease) in cash and cash equivalents 2,713 (9,807) 11,918 Cash and cash equivalents at beginning of year 3,190 12,997 1,079 Cash and cash equivalents at end of year $ 5,903 $ 3,190 $12,997
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 12
Income statement Reported 1 2 3 4 Recurring
1 Sales
2 COGS
3 Selling, general, and administrative costs
4 Other operating expenses
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit
8 Interest income
9 Other non-operating income (expense)
10 Other non-operating income (expense)
11 Other non-operating income (expense)
12 = EBIT
13 Gross interest expense
14 = EBT
15 Total tax expense
16 = Income from continuing operations
17 Equity income
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items
21 = Net income
22 Depreciation
23 Amortization
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24]
26 Operating EBITDA [rows 7, 22, 23,24]
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 13
Income statement Reported 1 2 3 4 Recurring
1 Sales
2 COGS
3 Selling, general, and administrative costs
4 Other operating expenses
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit
8 Interest income
9 Other non-operating income (expense)
10 Other non-operating income (expense)
11 Other non-operating income (expense)
12 = EBIT
13 Gross interest expense
14 = EBT
15 Total tax expense
16 = Income from continuing operations
17 Equity income
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items
21 = Net income
22 Depreciation
23 Amortization
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24]
26 Operating EBITDA [rows 7, 22, 23,24]
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 14
2011 Income statement Reported 1 2 3 Recurring
1 Sales 99,548 99,548
2 COGS (48,593) (48,593)
3 Selling, general, and administrative costs (21,102) (21,102)
4 Other operating expenses (6,546) (6,546)
5 Other operating expenses 0
6 Other operating expenses 0
7 = Operating Profit 23,307 0 23,307
8 Interest income 1,043 1,043
9 Other non-operating income (expense) (3,183) 3,183 0
10 Other non-operating income (expense) 0
11 Other non-operating income (expense) 0
12 = EBIT 21,167 3,183 24,350
13 Gross interest expense (1,392) (1,392)
14 = EBT 19,775 3,183 22,958
15 Total tax expense (8,665) (8,665)
16 = Income from continuing operations 11,110 3,183 14,293
17 Equity income 0
18 Non-Controlling Interest 0
19 Discontinued operations
20 Reclassified items (3,183) (3,183)
21 = Net income 11,110 0 11,110
22 Depreciation 2,050 2,050
23 Amortization 210 210
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24] 23,427 3,183 26,610
26 Operating EBITDA [rows 7, 22, 23,24] 25,567 0 25,567
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 15
2010 Income statement Reported 1 2 3 Recurring
1 Sales 78,684 78,684
2 COGS (38,599) (38,599)
3 Selling, general, and administrative costs (15,633) (15,633)
4 Other operating expenses (4,065) (4,065)
5 Other operating expenses
6 Other operating expenses
7 = Operating Profit 20,387 0 20,387
8 Interest income 1,091 1,091
9 Other non-operating income (expense) (846) 846 0
10 Other non-operating income (expense) 0
11 Other non-operating income (expense) 0
12 = EBIT 20,632 846 21,478
13 Gross interest expense (820) (820)
14 = EBT 19,812 846 20,658
15 Total tax expense (8,898) (8,898)
16 = Income from continuing operations 10,914 846 11,760
17 Equity income 0
18 Non-Controlling Interest
19 Discontinued operations
20 Reclassified items (846) (846)
21 = Net income 10,914 0 10,914
22 Depreciation 1,200 1,200
23 Amortization 148 148
24 Stock Based Compensation
25 Traditional [Credit] EBITDA [rows 12,22,23,24] 21,980 846 22,826
26 Operating EBITDA [rows 7, 22, 23,24] 21,735 0 21,735
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 16
Line # Par 2019 Adjusted CS 1 Revenue 99,548 100.0% 2 Cost of Sales (48,593) -48.8% 3 Selling, General (21,102) -21.2% 4 R & D (6,546) -6.6% 5 6 7 Operating Income 23,307 23.4%
Line # Par 2018 adjusted CS 1 Revenue 78,684 100.0% 2 Cost of Sales (38,599) -49.1% 3 Selling, General (15,633) -19.9% 4 R & D (4,065) -5.2% 5 6 7 Operating Income 20,387 25.9%
Line # Par Common Size
2019 Common Size 2018
1 Revenue 100.0% 100.0% 2 Cost of Sales -48.8% -49.1% 3 Selling, General -21.2% -19.9% 4 R & D -6.6% -5.2% 5 6 7 Operating Income 23.4% 25.9%
Line # Peers Common Size
2019 Common Size
2018 1 Revenue 100.0% 100.0% 2 Cost of Sales -46.7% -47.3% 3 Selling, General -21.1% -21.3% 4 R & D -7.2% -5.8% 5 6 7 Operating Income 25.0% 25.6%
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 17
2019 2018 Operating Profit Operating Assets RROOA
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 18
Revenues % Operating profit Non-recurring Adjusted OPM TATO RROA
1
2
3
4
5
6
Corporate
Total 100.0%
Revenues % Operating profit Non-recurring Adjusted OPM TATO RROA
1
2
3
4
5
6
Corporate
Total 100.0%
Barry M Frohlinger, Inc. 1981 – 2020 All content herein is copyright protected page 19
Revenues % Operating profit Non-recurring Adjusted OPM TATO RROA
1
2
3
4
5
6
Corporate
Total 100.0%
Revenues % Operating profit Non-recurring Adjusted OPM TATO RROA
1
2
3
4
5
6
Corporate
Total 100.0%