Reorganizing the Accounting Statements: In Practice  227
Reconciliation of Reported Taxes  To reconcile NOPAT to net income, it is 
helpful to first reconcile operating taxes to reported taxes. At the bottom of 
Exhibit 11.11, we present a reconciliation of reported taxes. The reconciliation 
includes the taxes related to nonoperating accounts and other nonoperating 
taxes. Although the two accounts sound similar, they are estimated differently.
The taxes related to nonoperating accounts, which equal –$15 million in 
2019, is calculated by multiplying the marginal tax rate by the sum of non-
operating accounts reported in the reconciliation of NOPAT to net income 
presented in Exhibit 11.9. For Costco, nonoperating accounts include interest 
expense, operating lease interest, interest income, and other income. To deter-
mine other nonoperating taxes, search the tax reconciliation table presented in 
Exhibit 11.10 for nonoperating items, such as one-time audits and write-offs. 
In the previous section, we classified taxes related to the 2017 Tax Cuts and 
Jobs Act (–$123 million) and the “other” account ($31 million) as nonoperat-
ing. Summing the two equals –$92 million.
Note how the reconciliation ties to the reported income taxes on the in-
come statement presented in Exhibit 11.8. Although reconciliation can be time-
consuming, it assures that the modeling has been carried out correctly.
Reconciliation to Net Income
To ensure that the reorganization is accurate, we recommend reconciling net 
income to NOPAT (see the lower half of Exhibit 11.9). To reconcile NOPAT, 
start with net income available to both common shareholders and noncontrol-
ling interests, and add back the increase (or subtract the decrease) in operating 
deferred-tax liabilities. We label this amount adjusted net income.
Next, add any nonoperating charges (or subtract any income) reported by 
the company, such as interest expense and other nonoperating expenses. After 
this, include any adjustments that have been made, like adjustments for oper-
ating lease interest and, if required, the nonoperating portion of the pension 
expense. Finally, subtract tax shields on the nonoperating expenses calculated 
previously and add any nonoperating taxes from the tax reconciliation table. 
Whether NOPAT is estimated using revenues less expenses or alternatively as 
net income plus nonoperating items and other adjustments, the result should 
be identical.
Free Cash Flow: In Practice
This subsection details how to build free cash flow from the reorganized fi-
nancial statements. For estimating free cash flow, the income statement and 
balance sheet will not suffice; the statement of shareholders’ equity also is re-
quired. Exhibit 11.12 presents the statement of shareholders’ equity for Costco. 
This statement reconciles the income statement with the balance sheet and 

228  Reorganizing the Financial Statements 
presents additional information required to estimate free cash flow and cash 
flow available to investors. Free cash flow is defined as:
FCF
NOPAT
Noncash Operating Expenses
Investments in
Invested Ca
=
+
−
pital
Exhibit 11.13 presents the free cash flow calculation for Costco and recon-
ciles free cash flow to cash flow available to investors. To create free cash flow, 
start with NOPAT and add back noncash expenses, such as depreciation and 
depletion. From gross cash flow, subtract investments in working capital, cap-
ital expenditures, and investments in other long-term assets net of liabilities.
Gross Cash Flow  Gross cash flow represents the cash operating profits that 
the company generates. It represents the cash available for investment and 
investor payout without the company having to sell nonoperating assets, 
such as excess cash, or to raise additional capital. Gross cash flow has two 
components:
1. NOPAT. As previously defined, net operating profit after taxes is the 
after-tax operating profit available to all investors.
2. Noncash operating expenses. Some expenses embedded in NOPAT are 
noncash and represent the economic decay of past investments. To 
convert NOPAT into cash flow, add back depreciation, depletion, and 
amortization of capitalized assets. Only add back amortization de-
ducted from revenues to compute NOPAT, such as the amortization of 
capitalized software or purchased customer contracts. Do not add back 
the amortization from acquired intangibles and impairments to NOPAT; 
EXHIBIT 11.12  Costco: Statement of Shareholders’ Equity
$ million
2015
2016
2017
2018
2019
Equity, beginning of year
12,303
10,617
12,079
10,778
12,799
Net income
2,377
2,350
2,679
3,134
3,659
Foreign-currency translation adjustment
(1,045)
22
85
(185)
(237)
Comprehensive income
1,332
2,372
2,764
2,949
3,422
Stock-based compensation
394
459
518
547
598
Stock options exercised
69
—
—
—
—
Release of vested restricted stock units
(122)
(146)
(165)
(217)
(272)
Repurchases of common stock
(494)
(477)
(473)
(322)
(247)
Cash dividends declared
(2,865)
(746)
(3,945)
(936)
(1,057)
Equity, end of year
10,617
12,079
10,778
12,799
15,243