Reformulated Financial Statements

Abstract

Conducting informative profitability and valuation analyses requires reformulating the financial statements to separate operating activities—the core of value creation—from financing and other nonoperating activities. It also requires distinguishing between recurring and transitory items in the income statement. This study provides a step-by-step explanation of the reformulation process, and it describes how the reformulated financial statements can be measured using Compustat data items. The latter part is important due to the many accounting details involved as well as to accounting changes over time. The informativeness of the reformulated financial statements constructed here is demonstrated in three companion studies (Nissim 2022a,b,c).

Keywords: Financial statements, profitability, financial statement analysis, earnings persistence, special items, recurring earnings, core earnings, earnings quality, free cash flow, forecasting, valuation

JEL Classification: G12, G17, G31, G32, M41