Non-Recurring Charges on the Income Statement (21:15)
In this tutorial, you will learn why non-recurring charges matter, how they impact a company’s financial statements and valuation, and how to find them and adjust for them in a financial statement analysis and valuation.
A common question we get is “How do you adjust for non-recurring charges when valuing and analyzing companies?”
There’s a ton of confusion around this question, which is made even worse by the fact that non-recurring charges RARELY make a huge difference in models and valuations.
Why Do Non-Recurring Charges Matter?
Because they could throw off financial statement analysis and multiples such as EV / EBITDA in the historical period.
Example: A company records a big write-down or a big Gain or Lossﾅ is that item really representative of the company’s ongoing, recurring business activities? NO!
Example for Alcoa: The big Goodwill Impairment charge of $1.7 billion really throws things off in Year 2, so we should consider adding it back when calculating metrics like EBIT and EBITDA.
Butﾅ does this really matter for valuation / financial modeling / analytical purposes?
I would say, “No” because it’s not in the most recent period – and normally you focus on the LTM or Last Fiscal Year figures when calculating valuation multiples.
So you care more about very recent or anticipated non-recurring charges.
How Do You Find Non-Recurring Charges?
Easy Method: Look at the Income Statement and the Cash Flow Statement and search for anything that might be “non-recurring,” i.e. it does not appear in every year
It does NOT matter whether an item is cash or non-cash – all that matters is whether or not it impacts the metric you are calculating, such as EBIT or EBITDA.
Companies will often, though not always, list major non-recurring items on the IS and CFS. Examples for Alcoa:
Goodwill Impairment: This is clearly a non-recurring charge that should be added back, since it appears in only one of six historical years.
Restructuring: We are NOT adding back Restructuring because it’s effectively a recurring item here.
Stock-Based Compensation, Provision for Doubtful Accounts, etc.: These are non-cash items, but they’re also very much recurring items, so we do not add them back.
Gains and Losses: We might add these back, but need to determine where they appear on the Income Statement first.
Anything Else: Other charges might exist as wellﾅ we need to do some detective work to find them, time permitting.
The Hardcore Method of Finding Non-Recurring Charges
If you have the time or need a lot more detail, you can sift through the Notes to the Financial Statements and look up possible non-recurring charges in each section.
COGS: A few write-downsﾅ but are they non-recurring? We would say, “no.”
Other Income: Gains from CFS appear there – so we don’t add these back since they don’t impact EBIT or EBITDA at all.
Restructuring: Could make the case that the Loss is non-recurringﾅ but even that is debatable. In this case, however, we will add back the “Loss from Divestiture” portion.
The Restructuring Charge is on pg. 107 of the 10-K and the Gains and Losses are on pg. 133 of the 10-K.
Do You Adjust for Non-Recurring Charges?
You don’t “adjust” the historical statements themselves – only metrics like EBIT, EBITDA, etc.
Criterion #1: Is it really non-recurring? Really? HAS NOTHING TO DO WITH CASH VS. NON-CASH!
Criterion #2: Does it actually impact the metric you are adding it back to?