Reorganizing the Accounting Statements: In Practice  217 should be considered excess.5 In 2019, Costco held just under $9.5 billion in cash and marketable securities on $152.7 billion in revenue. At 2 percent of revenue, operating cash equals $3.1 billion. The remaining cash of $6.4 billion is treated as excess. Exhibit 11.5 separates operating cash from excess cash. Excess cash is not included in invested capital, but rather is treated as a non- operating asset. Nonconsolidated Subsidiaries and Equity Investments  Nonconsolidated subsidiaries, also referred to as investments in associates, investments in af- filiated companies, and equity investments, should be measured and valued separately from invested capital. When a company owns a minority stake in another company, it will record the investment as a single line item on the balance sheet and will not record the individual assets owned by the subsid- iary. On the income statement, only the net income from the subsidiary will be recorded on the parent’s income statement, not the subsidiary’s revenues or costs. Since only net income—not revenue—is recorded, including noncon- solidated subsidiaries as part of operations will distort margins and capital turnover. Therefore, we recommend separating nonconsolidated subsidiaries from invested capital and analyzing and valuing nonconsolidated subsidiar- ies separately from core operations. Financial Subsidiaries  Some companies, including General Motors and Sie- mens, have financing subsidiaries that finance customer purchases. Because these subsidiaries charge interest on financing for purchases, they resemble banks. Since bank economics are quite different from those of manufacturing and service companies, you should separate line items related to the financial subsidiary from the line items for the manufacturing business. Then evalu- ate the return on capital for each type of business separately. Otherwise, sig- nificant distortions of performance will make a meaningful comparison with competitors impossible. For more on how to analyze and assess financial sub- sidiaries, see Chapter 19. Overfunded Pension Assets  If a company runs a defined-benefit pension plan for its employees, it must fund the plan each year. And if a company funds its plan faster than its pension expenses dictate or assets grow faster than expected, under U.S. Generally Accepted Accounting Principles (GAAP) and International Accounting/Financial Reporting Standards (IAS/IFRS) the 5 This aggregate figure, however, is not a rule. Required cash holdings vary by industry. For instance, one study found that companies in industries with higher cash flow volatility hold higher cash bal- ances. To assess the minimum cash needed to support operations, look for a minimum clustering of cash to revenue across the industry. To better understand the reason behind significant cash holdings in a historical context, see J. Graham and M. Leary, “The Evolution of Corporate Cash,” SSRN working paper (May 25, 2018). 218  Reorganizing the Financial Statements company can recognize a portion of the excess assets on the balance sheet. Pension assets are considered a nonoperating asset and not part of invested capital. Their value is important to the equity holder, so they will be valued later, but separately from core operations. Chapter 23 examines pension assets in detail. Tax Loss Carryforwards  Unless they are small and grow consistently with revenue, do not include tax loss carryforwards—also known as net operating losses (NOLs)—as part of invested capital. Depending on the type of deferred- tax asset, it will be valued either separately or as part of operating cash taxes. Given the complexity of reorganizing deferred taxes, we discuss them in more detail later in this chapter, in the subsection titled “Equity Equivalents Such as Deferred Taxes.” Other Nonoperating Assets  Other nonoperating assets, such as deriva- tives, excess real estate, and discontinued operations, also should be ex- cluded from invested capital. For Costco, derivatives were disclosed in the footnotes but were immaterial, so no adjustments were made to the balance sheet accounts. Reconciling Total Funds Invested Total funds invested can be calculated as invested capital plus nonoperating assets, as in the previous section, or as the sum of debt, equity, and their equiv- alents. The totals produced by the two approaches should reconcile. A sum- mary of sources of financing appears in Exhibit 11.6. We next examine each of these sources of capital contributing to total funds invested. EXHIBIT 11.6  Sources of Financing Source of capital Description Debt Interest-bearing debt from banks and public capital markets Debt equivalents Off-balance-sheet debt and one-time debts owed to others that are not part of ongoing operations (e.g., severance payments as part of a restructuring, an unfunded pension liability, or expected environmental remediation following a plant closure) Equity Common stock, additional paid-in capital, retained earnings, and accumulated other comprehensive income Equity equivalents Balance sheet accounts that arise because of noncash adjustments to retained earnings; similar to debt equivalents but not deducted from enterprise value to determine equity value (e.g., most deferred-tax accounts and income-smoothing provisions) Hybrid securities Claims that have equity characteristics but are not yet part of owners’ equity (e.g., convertible debt and employee options) Noncontrolling interest by other companies External shareholders’ minority position in any of the company's consolidated subsidiaries