Nonoperating Expenses, One-Time Charges, Reserves, and Provisions
To project future cash flows from ongoing operations, you would typically focus on expenses above earnings before interest, taxes, and amortization (EBITA), such as cost of sales, distribution expenses, selling expenses, and administrative expenses. But what about nonoperating expenses, such as business realignment expenses, goodwill impairment, and extraordinary items? Nonoperating expenses are infrequent or unusual charges that are indirectly related to the company’s typical activities and not expected to recur. The conventional wisdom is to ignore nonoperating expenses in discounted cash flow (DCF) calculations as backward-looking, one-time costs. Yet research shows that the type and accounting treatment of nonoperating expenses can affect future cash flow and must be incorporated into operating cash flow.
In addition to making forecasts more precise, adjustments for nonoperating expenses will also make assessments of past performance more accurate. For instance, before 2009, purchased in-process R&D for U.S. companies was written off at the time of purchase.400
This artificially lowered acquired intangibles and retained earnings. To assess historical return on invested capital (ROIC) properly, you need to make adjustments for this type of nonoperating item.
This chapter analyzes nonoperating expenses that appear between EBITA and earnings before taxes. Typical nonoperating expenses include amortization