Reorganizing the Accounting Statements: In Practice  215
operating activity. For instance, one manufacturer records long-term customer 
advances within other liabilities. In general, however, most long-term liabili-
ties are not operating liabilities, but rather what we deem debt and equity 
equivalents. These include unfunded pension liabilities, unfunded postretire-
ment medical costs, restructuring reserves, and deferred taxes.
Where can you find a breakdown of other assets and other liabilities in the 
annual report? In some cases, companies provide a comprehensive table in the 
footnotes. Most of the time, however, you must work through the footnotes, 
note by note, searching for items aggregated within other assets and liabilities.
Goodwill and Acquired Intangibles  In Chapter 12, return on invested capital 
is analyzed both with and without goodwill and acquired intangibles. ROIC 
with goodwill and acquired intangibles measures a company’s ability to cre-
ate value after paying acquisition premiums. ROIC without goodwill and ac-
quired intangibles measures the competitiveness of the underlying business. 
For example, our colleagues studied the return on capital for large consumer 
packaged-goods companies from 1963 through 2009. What they found was 
intriguing. From the 1960s through the mid-1980s, the median ROIC without 
goodwill of these companies was consistently in the mid-teens. ROIC with 
goodwill was only slightly lower. Then, beginning in the mid-1980s, the com-
panies were able to use the power of their brands to increase their ROIC with-
out goodwill to a median of almost 35 percent. At the same time, they also 
stepped up their acquisition activity. Their median ROIC including goodwill 
remained in the mid to high teens. By 2009, the gap between the ROIC with 
goodwill and ROIC without goodwill was 17 percentage points. When you 
are analyzing the performance of a company, it’s critical to understand ROIC 
with and without goodwill.
To evaluate the effect of goodwill and acquired intangibles properly, you 
should make two adjustments. First, subtract deferred-tax liabilities related 
to the amortization of acquired intangibles.4 Why? When amortization is 
not tax deductible, accountants create a deferred-tax liability at the time of 
the acquisition that is drawn down over the amortization period (since re-
ported taxes will be lower than actual taxes). To counterbalance the liability, 
acquired intangibles are artificially increased by a corresponding amount, 
even though no cash is laid out. Subtracting deferred taxes related to ac-
quired intangibles eliminates this distortion. For companies with significant 
acquired intangibles—for example, Coca-Cola—the adjustment can be sub-
stantial.
Second, add back cumulative amortization and impairment. Unlike other 
fixed assets, goodwill and acquired intangibles do not wear out, nor are they 
replaceable. Therefore, you need to adjust reported goodwill and acquired 
4 Since goodwill is tested regularly for impairment and cannot be amortized, this issue relates only to 
acquired intangibles.

216  Reorganizing the Financial Statements 
intangibles upward to recapture historical impairments of goodwill and amor-
tization of intangibles. (To maintain consistency, do not deduct impairments 
of goodwill or amortization of acquired intangibles from revenues to deter-
mine NOPAT. This is why NOPAT starts with EBITA.)
Consider FedEx, which wrote down approximately $900 million in good-
will and acquired intangibles when it converted the acquired brand name 
Kinko’s to FedEx Office. Failing to add back this impairment would have 
caused a large artificial jump in return on invested capital following the write-
down. The money spent on an acquisition is real and needs to be accounted 
for, even when the investment loses value.
Computing Total Funds Invested
Invested capital represents the capital necessary to operate a company’s core 
business. In addition to invested capital, companies can also own nonoperat-
ing assets. The combination of invested capital and nonoperating assets leads 
to total funds invested. Nonoperating assets include excess cash and mar-
ketable securities, receivables from financial subsidiaries (for example, credit 
card receivables), nonconsolidated subsidiaries, overfunded pension assets, 
and tax loss carry-forwards. Costco has two nonoperating assets: excess cash 
and foreign tax credit carryforwards.
There are two reasons to diligently separate operating and nonoperating 
assets. First, nonoperating assets can distort performance measures for both 
economic and accounting reasons. For example, many nonoperating assets 
generate income, but companies do not report the income unless certain own-
ership thresholds are met. Including an asset without its corresponding in-
come distorts performance measurements. Second, there are better methods 
than discounted cash flow to value nonoperating assets. You would never 
discount interest income to value excess cash. For this asset, the book value 
suffices.
Now let’s examine the most common nonoperating assets.
Excess Cash and Marketable Securities  Do not include excess cash in in-
vested capital. By its definition, excess cash is unnecessary for core operations. 
Rather than mix excess cash with core operations, analyze and value excess 
cash separately. Given its liquidity and low risk, excess cash will earn very 
small returns. Failing to separate excess cash from core operations will incor-
rectly depress the company’s apparent ROIC.
Companies do not disclose how much cash they deem necessary for op-
erations. Nor does the accounting definition of cash versus marketable se-
curities distinguish working cash from excess cash. Based on past analysis, 
companies with the smallest cash balances held cash just below 2 percent 
of sales. If this is a good proxy for working cash, any cash above 2 percent