What was the best aspect of the course that you can put to use in your career?

This module is one of the most important ones we cover because the income statement serves as a baseline that we adjust and ultimately use to formulate a projection of net income or cash flows. Not only is it important to understand the historical trends in the income statement, but it’s also critical to know the valuation principles being applied within all of those statements as well as any changes that may have occurred over the years.

The example of differing revenue valuation principles was mentioned in the Module One overview and is related to the income statement. Another great example is that of inventory valuation and costing. Under U.S. generally accepted accounting principles (GAAP), there are four main methods used to value inventory: (1) the separate identification method, (2) LIFO (last in first out) method, (3) FIFO (first in first out) method, and (4) the weighted average cost method. International Financial Reporting Standards (IFRS) allow all of these except for LIFO. The accounting policy chosen is extremely important, especially for companies that manufacture goods of any kind. In periods of increasing materials prices, inventory accounted for under the FIFO method will yield a higher ending inventory balance and a lower cost of goods sold for the period, inflating earnings because the inventory being expensed on the income statement is valued at the lower prices of inventory purchased in earlier periods. As an analyst, you must recognize these situations and adjust the financial statements to put them on a level playing field with other comparable firms. We’ll talk more about normalization adjustments in Module Seven.

Another key focus in this module is understanding ways to accurately measure the income streams generated by your company. This can be skewed by things such as write-offs, impairment charges, unusual or infrequent events, or unrealized gains in investments. Many of these items are noncash and represent only a decline in value, not an outflow of cash. Thus, it becomes important to either remove them from the financial statements or calculate some type of alternative measure of earnings. Your textbook covers several alternative methods of profit, such as comprehensive income, EBIT (earnings before interest and taxes), EBITDA (earnings before interest, taxes, depreciation, and amortization), and NOPAT (net operating profit after taxes). These are all unique ways to measure value and may be better suited for some organizations than others (Baginski, Bradshaw, & Wahlen, 2018).

In this week’s milestone, you’ll take the concepts we’ve learned so far and use them to construct an overview of your chosen company’s balance sheet, income statement, and statement of cash flows. You’ll want to focus on major line items, with a strong emphasis on changes from year to year. A good place to start is by performing a vertical and horizontal analysis. With a vertical analysis, you’re looking at particular line items as a percentage of either total assets (for the balance sheet) or total revenue (for the income statement). A horizontal analysis involves looking at trends over time in either the numbers produced from a vertical analysis or in the actual figures themselves. For example, if you notice that cost of goods sold as a percentage of sales in year 2016 is 75 percent and jumps to 80 percent in 2017, then you know something happened. It could be a decrease in sales, an increase in raw materials, or some other factor. Either way, this will give you material to investigate and report on in your milestone.

Understanding these topics from the text will help you better project net income and cash flows, and it will help you understand how the classification or recognition of all items on the income statement or statement of cash flows relate to these projections.

The table below first lists income statement line items, then the text reference and the different topics discussed in the text that could impact projections.