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Specific costs or revenues that a regulatory agency permits a U.S. public utility (usually
an energy company) to defer to its balance sheet. These amounts would otherwise be
required to appear on the company's income statement and would be charged against
current expenses or revenues.
Deferred Charge
A deferred charge is a long-term prepaid expense that is treated as an asset on
a balance sheet and is carried forward until it is actually used. Deferred charges often
stem from a business making a payment for a good or service that it has not yet
received, such prepaying insurance premiums or rent.
Deferred revenue, on the other hand, refers to money that the company has received as
payment before a product or service has been delivered. A prime example of a deferred
revenue is the opposite side of the rental agreement. A tenant who pays for rent one
year in advance may have a happy landlord, but that landlord must account for the
rental revenue over the life of the rental agreement, not in one lump sum. As each
month approaches, the company uses a portion of the funds from deferred revenue and
recognizes this portion as revenue in the financial statements. As is the case with
deferred charges, deferred revenue ensures that revenues for the month are matched
with the expenses incurred for that month.
A partners interest in a partnership is tracked in the partners capital account, and the
account is increased by any cash or assets contributed by the partner, along with the
partners share of profits. The partners interest is reduced by any withdrawals or
guaranteed payments, and by the partners share of partnership losses. A withdrawal up
to the partners capital account balance is considered a return of capital and is not a
taxable event. Once the entire capital account balance is paid to the partner, however,
any additional payments are considered income to the partner and are taxed on the
partners personal tax return.
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Another method of calculating invested capital is to add the book value of a company's
equity to the book value of its debt, then subtract non-operating assets, including cash
and cash equivalents, marketable securities and assets of discontinued operations.
The value in the numerator can also be calculated in a number of ways. The most
straightforward way is to subtract dividends from a company's net income.
On the other hand, because a company may have benefited from a one-time source of
income unrelated to its core business a windfall from foreign exchange rate
fluctuations, for example it is often preferable to look at net operating profit after taxes
(NOPAT). NOPAT is calculated by adjusting the operating profit for taxes: (operating
profit) * (1 - effective tax rate). Many companies will report their effective tax rates for
the quarter or fiscal year in their earnings releases, but not all. Operating profit is also
referred to as earnings before interest and tax (EBIT).
One downside of this metric is that it tells nothing about what segment of the business is
generating value. If you make your calculation based on net income (minus
dividends) instead of NOPAT, the result can be even more opaque, since it is possible
that the return derives from a single, non-recurring event.
ROIC provides necessary context for other metrics such as the P/E ratio. Viewed in
isolation, the P/E ratio might suggest a company is oversold, but the decline could be
due to the fact that the company is no longer generating value for shareholders at the
same rateor at all. On the other hand, companies that consistently generate high
rates of return on invested capital probably deserve to trade at a premium to other
stocks, even if their P/E ratios seem prohibitively high.
In Target Corp.'s (TGT) first-quarter 2015 earnings release, the company calculates its
trailing twelve month ROIC, showing the components that go into the calculation:
TTM TTM
(All values in million of U.S. dollars)
5/2/15 5/3/14
Earnings from continuing operations before
4,667 4,579
interest expense and income taxes
+ Operating lease interest * 90 95
- Income taxes 1,575 1,604
Net operating profit after taxes 3,181 3,070
It begins with earnings from continuing operations before interest expense and income
taxes ($4,667 million), adds operating lease interest ($90 m), then subtracts income
taxes ($1,575 m), yielding a net profit after taxes of $3,181 m: this is the numerator.
Next it adds the current portion of long-term debt and other borrowings ($112 m), the
noncurrent portion of long-term debt ($12,654 m), shareholders equity ($14,174 m) and
capitalized operating lease obligations ($1,495 m). It then subtracts cash and cash
equivalents ($2,768 m) and net assets of discontinued operations ($335 m), yielding
invested capital of $25,332 m. Averaging this with the invested capital from the end of
the prior-year period ($25,680 m), you end up with a denominator of $25,506 m. The
resulting after-tax return on invested capital is 12.5%.
This calculation would have been difficult to obtain from the income statement and
balance sheet alone, since the asterisked values are buried in an addendum. For this
reason calculating ROIC can be tricky, but it is worth arriving at a ballpark figure in order
to assess a company's efficiency at putting capital to work. Whether 12.5% is a good
result or not depends on Target's cost of capital. Since this is often between 8% and
12%, it is likely that Target is creating value, but slowly and with a thin margin for error.