Mergers, Acquisitions, Divestitures, and Other Restructurings. Paul Pignataro

is composed of interest expense and interest income. Interest expense is the cost incurred on debt that the company has borrowed. Interest income is commonly the income received from cash held in savings accounts, certificates of deposit, and other investments.

      Let's assume the car company has taken out $1 million in loans and incurs 10 percent of interest per year on those loans. So the car company has $100,000 in interest expense per year, or $25,000 per quarter. We can also assume that the company has $50,000 of cash and generates 1 percent of interest income on that cash per year ($500), or $125 per quarter.

      Often, the interest expense is netted against the interest income as net interest expense.

      EBT

      Earnings before taxes (EBT) can be defined as EBIT minus net interest.

      Notice we have also calculated EBT margin, which is EBT divided by revenue.

      Taxes

      Taxes are the financial charges imposed by the government on the company's operations. Taxes are imposed on earnings before taxes as defined previously. In the car example, we can assume the tax rate is 35 percent.

      Net Income

      Net income is calculated as EBT minus taxes. The complete income statement follows.

      Nonrecurring and Extraordinary Items

      Nonrecurring and extraordinary items or events are income or expenses that either are one-time or do not pertain to everyday core operations. Gains or losses on sales of assets or from business closures are examples of nonrecurring events. Such nonrecurring or extraordinary events can be scattered about in a generally accepted accounting principles (GAAP) income statement, so it is the job of a good analyst to identify these items and move them to the bottom of the income statement in order to have EBITDA, EBIT, and net income line items that represent everyday, continuous operations. We call this “clean” EBITDA, EBIT, and net income. However, we do not want to eliminate those nonrecurring or extraordinary items completely, so we move them to the section at the bottom of the income statement. From here on out we will refer to both nonrecurring and extraordinary items simply as “nonrecurring items” to simplify.

      Distributions

      Distributions are broadly defined as payments to equity holders. These payments can be in the form of dividends or noncontrolling interest payments, to name the major two types of distributions.

      Noncontrolling interest is the portion of the company or the company's subsidiary that is owned by another outside person or entity. If another entity (Entity A) owns a noncontrolling interest in the company (Entity B), Entity B must distribute a portion of Entity B's earnings to Entity A.

      Net Income (as Reported)

      Because we have recommended moving some nonrecurring line items into a separate section, the net income listed in the previous example is effectively an adjusted net income, which is most useful for analysis, valuation, and comparison. However, it is important to still represent a complete net income with all adjustments included to match the original given net income. So it is recommended to have a second net income line, defined as net income minus nonrecurring events minus distributions, as a sanity check.