A.1. Comparative Financial Statement Analysis

Question 1

What is the difference between operating income and EBIT?

Answer 1

• Operating income does not include interest and dividend income, whereas EBIT does.
• Operating income does not include non-operating gains and losses, whereas EBIT does.
• Operating income does not include pre-tax gains and losses on discontinued operations, whereas EBIT does.

Neither EBIT nor operating income include deductions for interest expense or taxes.

Question 2

How is EBIT (Earnings Before Interest and Taxes) calculated?

Answer 2

Net Income + Interest Expense + Tax Expense

Question 3

What does Income from Continuing Operations include?

Answer 3

• Revenues and expenses from core business
• Financial income and expenses
• Non-operating gains and losses
• Income taxes on continuing operations

Income from continuing operations excludes income from discontinued operations, which represents income or loss not expected to continue.

Question 4

True or False:

EBIT appears as a line item on a standard multi-step income statement.

Answer 4

False

EBIT is not a GAAP metric. It is a calculated amount used in financial statement analysis and does not appear as a line item on a standard multi-step income statement.

Since EBIT is not a GAAP metric, publicly owned companies are discouraged by the SEC from reporting it on their financial statements. The SEC mandates that the reporting of any non-GAAP financial measure must be reconciled back to an appropriate GAAP measure, which in the case of EBIT is net income.

Question 5

How is Earnings Before Taxes (EBT) calculated?

Answer 5

Net Income + Tax Expense

Question 6

What is the purpose of comparative financial statement analysis?

Answer 6

To address size differences when comparing financial statements of different companies or different periods for the same company by expressing each item as a percentage of a relevant base amount.

Question 7

What is vertical analysis in financial statements?

Answer 7

Also known as common-size financial statements, it expresses each component of a financial statement as a percentage of a total, enabling comparison of performance across companies of different sizes.

Question 8

What is horizontal trend analysis in financial statement analysis?

Answer 8

It is used to evaluate trends for a single business over several years, using methods like common base year analysis and variation analysis.

Question 9

What is a base year analysis in financial statement analysis?

Answer 9

It uses the first year presented as the base year, with subsequent years’ financial statement amounts presented as index numbers relative to the base year index number.

Base number financial statement analysis is also called index number analysis.

Question 10

How is the annual growth rate of a line item calculated in variation analysis?

Answer 10

Annual Growth Rate of Line Item (%) = (Current Year Line Item Amount / Previous Year Line Item Amount) − 1 × 100

Question 11

What sources provide industry common-size financial statements?

Answer 11

• ProSight Statement Studies published by ProSight Financial Association (formerly published by Risk Management Association, which merged with Bank Administration Institute to form ProSight)
• Dun & Bradstreet® Key Business Ratios on the Web (KBR), published by Mergent, Inc.