SUMMARY TO ANALYZING BUSINESS EARNINGS
An estimation of the sustainable portion of earnings should be the centerpiece of analyzing business earnings. This task has become a far greater challenge over the past decade as the number of nonrecurring items has increased dramatically. This explosion has been driven by corporate reorganizations and associated activities. Some of the labels attached to these producers of nonrecurring items are restructuring, rightsizing, downsizing, reengineering, redeployment, repositioning, reorganizing, rationalizing, and realignment. The following are some key points for the reader to consider:
• An earnings series from which nonrecurring items have been purged is essential in order to both evaluate current trends in operating performance and make projections of future results.
• The identification and measurement of nonrecurring items will typically require the exercise of judgment.
• There are no agreed-upon definitions of nonrecurring items as part of GAAP. Moreover, a variety of labels are used beyond the term nonrecurring and they include special, unusual, nonoperating, and noncore.
• It is common to treat items as nonrecurring even though they may appear with some regularity in the income statement. However, these items are usually very irregular in terms of their amount as well as whether they are revenues/gains or expenses/losses.
• The key question to pose in making the nonrecurring judgment is: Will underlying trends in operating performance be obscured if the item remains in earnings?
• Many material nonrecurring items will be separately disclosed on the face of the income statement. However, a substantial number will be disclosed in other statements and locations. It is typically necessary to extend the search for nonrecurring items well beyond the income statement.
• In response to reductions in the time available for a whole range of important activities, an efficient and abbreviated search sequence is presented in the chapter and illustrated with a comprehensive case example.
While a comprehensive review of all financial reporting is the gold standard, reliable information on sustainable earnings can typically be developed while employing only a subset of reported financial information.