What Are Adjusted Earnings and How Are They Calculated?

Adjusted earnings are a financial metric that companies use to present their performance by modifying standard earnings figures. These figures are not calculated using Generally Accepted Accounting Principles (GAAP), the standard accounting rules public companies must follow in the United States. Instead, adjusted earnings start with a GAAP-based number, typically net income, and then add or subtract certain items that management believes do not reflect the company’s core, ongoing business operations. The adjustments often involve removing the financial impact of events that are considered one-time or non-cash to provide a clearer view of operational performance.

The Purpose of Non-GAAP Metrics

Companies use non-GAAP metrics like adjusted earnings to provide a view of their performance “through the eyes of management.” The primary rationale is to present a clearer picture of the core, ongoing operational health of the business. This is achieved by excluding certain expenses or gains that management considers to be outside of normal day-to-day operations, potentially distorting underlying performance trends.

While GAAP rules are designed to ensure consistency, they sometimes include items that can make a company’s periodic results volatile. By presenting an adjusted number, a company attempts to show investors what its performance would have looked like without these specific items.

Common Adjustments to GAAP Earnings

A frequent adjustment made to arrive at adjusted earnings is the amortization of acquired intangible assets. When one company acquires another, it often records intangible assets on its balance sheet, such as customer relationships, brand names, or proprietary technology. Under GAAP, the value of these assets is expensed over their useful life through a non-cash charge called amortization.

Stock-based compensation is another significant and common adjustment. Companies, particularly in the technology sector, often pay employees with stock options or restricted stock units. GAAP requires that the fair value of this equity compensation be recorded as an expense on the income statement, but because this is a non-cash expense, companies often add it back to their GAAP net income.

Restructuring and severance costs are also typically excluded from adjusted earnings. These expenses arise when a company undergoes a significant reorganization, which might include closing facilities or laying off employees. Management views these as one-time or infrequent events that are not part of the company’s core, recurring operational activities.

Acquisition-related expenses are another category of costs that companies often adjust for. These can include investment banking fees, legal and accounting costs, and other professional service fees incurred during a merger or acquisition. Since these costs are directly tied to a specific transaction, they are frequently excluded from adjusted earnings.

Litigation settlements or other significant, one-time legal costs are also commonly removed. A large, unexpected legal settlement can have a substantial impact on a company’s reported GAAP net income, while an impairment is a non-cash charge that occurs when the carrying value of an asset on the balance sheet exceeds its recoverable amount. Companies exclude these items, arguing they are non-recurring and do not reflect core operational performance.

Calculating Adjusted Earnings

The calculation of adjusted earnings begins with a company’s net income, which is determined according to GAAP and found at the bottom of the income statement. From this starting point, a series of adjustments are made, adding back certain expenses and sometimes subtracting certain gains.

For a practical example, consider a company that reports a GAAP Net Income of $500 million for the year. The company might disclose that this figure includes $100 million in amortization of intangible assets and $50 million in one-time restructuring costs. The calculation would be: $500 million (GAAP Net Income) + $100 million (Amortization) + $50 million (Restructuring Costs) = $650 million (Adjusted Earnings).

Investors can find the specific details of these calculations in a company’s financial reports, such as quarterly earnings releases or annual filings with the Securities and Exchange Commission (SEC). A document to locate is the reconciliation table, which the SEC requires to show how the non-GAAP figure was derived from the most directly comparable GAAP measure.

Investor Analysis and Interpretation

When analyzing a company’s financial health, looking at the trend of adjusted earnings over several quarters or years can provide insight into the performance of the core business as defined by management. This analysis should not be done in isolation; it is important to analyze the trend of GAAP earnings alongside it.

A consistently large or widening gap between GAAP and adjusted earnings should prompt further investigation. If a company is constantly reporting adjusted earnings that are significantly higher than its GAAP net income, it may indicate that “one-time” charges are happening frequently, painting an overly optimistic picture. Comparing the adjustments between two competing companies in the same industry can also be a valuable analytical technique.

Regulatory Oversight of Adjusted Figures

The use of non-GAAP financial measures like adjusted earnings is regulated by the U.S. Securities and Exchange Commission (SEC). The primary rules are found in Regulation G, which was adopted to ensure that when companies present these alternative figures, they do so in a way that is not misleading.

One of the requirements under SEC rules is that a non-GAAP measure cannot be presented with greater prominence than the most directly comparable GAAP measure. The GAAP figure must be given equal or greater importance in the disclosure.

A central component of this regulation is the mandatory reconciliation. Whenever a company discloses a non-GAAP financial measure, it must provide a clear and understandable reconciliation to the most comparable GAAP measure, showing all of the adjustments. Regulation G also explicitly prohibits companies from presenting non-GAAP financial measures that are misleading, such as by excluding normal, recurring cash operating expenses.