If you have a solid handle on financial statements, that gives you an advantage in conducting investment research. The income statement, one of three financial statements, shows how much money a company made during a time period. This information is vital to understanding the financial health of a company, as well as how wise of an investment it might be.
There are accounts such as revenue, cost of goods sold, operating expenses, interest expense, interest income and others on this statement. There also are times when you see evidence of restructuring costs on income statement figures, in the form of accrual. That means that the company incurred the restructuring expense during that time period.
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Understanding Restructuring Costs
According to Investopedia, restructuring costs involve either the costs in writing down the cost of assets because the assets have lost value, or the costs of closing a business and letting people go. These costs are usually not part of the normal operations of a business, and analysts exclude them from their earnings number because of that. It is wise to be aware of this so that you know what to look for when considering a potential investment. Companies know that analysts exclude restructuring costs from earnings; they sometimes take advantage of this and try to fit more costs into restructuring that are really just part of normal operations to make their earnings look better.
Consider also: What are Financial Statement Disclosures?
Accrual Accounting Basics
Accounting Tools reports that the U.S. Generally Accepted Accounting Principles (GAAP) fall under an accrual system. This basically means that revenues are recognized when the company fulfills its obligation of the sale, while expenses are recognized when they occur. Therefore, you don't need to have a cash outlay to have an expense, and you don't need to have a cash inflow to record revenue. This is different from how many people structure their own personal finances, so understanding this is key to wise investing. Because of the timing difference between recognition of expenses and revenues and the inflow and outflow of cash, accruals occur and fall on the balance sheet.
Consider Also: Do Accrued Expenses Affect an Income Statement?
How It Works: Restructuring Accrual
A restructuring accrual occurs when the restructuring is actually incurred. However, there doesn't have to be a cash outlay for the expense. For example, if a company lays off a group of people and gives them 12 months of severance pay due at the end of each month, the company incurs the expense when the people are laid off and recognizes it on the income statement then. However, the cash outlay occurs for the next 12 months.
Analyzing Restructuring Accruals
One way to look at restructuring accruals is averaging them out over a few years to smooth out the fluctuations. That way, you're able to get a better picture of the company's long-term earnings power than if you look only at one year at a time. When you look at a company in this way, you will not have either too high or too low of an earnings figure for the company and will be more likely to value the company properly. This proper valuation is key to seeing trends in performance over time and to deciding whether or not it makes a wise addition to your investment portfolio.