What it means
Reported profit follows accounting standards, which require everything to pass through the income statement in the period it occurs. That is correct but noisy: a redundancy programme, a legal settlement or a gain on selling a building can swing profit by millions while telling you nothing about next year.
Adjusted earnings attempts to isolate the recurring core. Analysts and boards use it for forecasting, for valuing a business on a multiple of profit, and for setting management bonuses.
The common add-backs are restructuring and redundancy costs, impairment write-downs, acquisition and legal fees, share-based payment charges, and the profit or loss on disposing of assets. Gains are supposed to be deducted just as losses are added back, and the quickest test of an over-optimistic adjusted figure is to check whether the company ever removes anything favourable.
This is where scepticism earns its keep. Restructuring costs that appear in every single annual report are not one-off, and a business that excludes the same category five years running is describing its normal cost base rather than an exception.
Buyers of private companies use a close cousin called adjusted or normalised EBITDA, which also removes the owner's above-market salary, personal costs run through the company and rent paid to a related party. Those adjustments are legitimate, but each one needs evidence, because the sale price is usually a multiple of the adjusted figure.
In practice
Real-world examples
Example 1
A listed grocery chain reports a $40,000,000 loss after writing down the value of 30 underperforming stores, and presents adjusted earnings of $22,000,000 excluding the impairment. Investors accept the adjustment for forecasting purposes but note that the write-down implies those stores will generate less cash in future.
Example 2
An accountant preparing a dental practice for sale adds back $90,000 of the owner's $180,000 salary, since a replacement dentist would cost $90,000, plus $25,000 of personal travel run through the books. Adjusted earnings rise by $115,000, which at a five times multiple adds 5 x $115,000 = $575,000 to the asking price.
Example 3
A manufacturer's bonus scheme pays on adjusted operating profit, and the finance director proposes excluding a $2,000,000 factory relocation. The remuneration committee refuses, on the grounds that the move was a management decision and excluding it would pay a bonus for spending money.
Think of it
Imagine baking a cake for your cafe every day. Today, you accidentally dropped your phone into the mixing bowl and had to buy a replacement phone. Your daily profit took a massive hit, but that does not mean your baking business is failing. Adjusted earnings are like calculating your profit while ignoring the cost of the dropped phone, showing what the cakes actually earned.
Formula
Calculation
Adjusted earnings = reported net profit + non-recurring expenses - non-recurring gains
A packaging company reports net profit of $2,100,000 on revenue of $30,000,000. During the year it settled a patent dispute for $600,000, spent $450,000 closing a plant, recorded a $350,000 share-based payment charge, and booked an $800,000 gain on selling a surplus depot.
Adjusted earnings = $2,100,000 + $600,000 + $450,000 + $350,000 - $800,000 = $2,700,000. The reported margin is $2,100,000 / $30,000,000 = 7% and the adjusted margin is $2,700,000 / $30,000,000 = 9%.
That difference is not academic. On an eight times multiple, the reported figure supports a value of 8 x $2,100,000 = $16,800,000 while the adjusted figure supports 8 x $2,700,000 = $21,600,000, so $4,800,000 of value rests entirely on which profit number the buyer accepts.Case study
Seen in the real world
The following is an illustrative and entirely fictional example. Halewick Logistics, an invented regional haulier, was marketed for sale on reported net profit of $1,200,000 and a set of add-backs the seller's adviser described as clearly one-off: $600,000 of restructuring, $250,000 of legal fees from a contract dispute, $300,000 of owner salary above market rate, and $150,000 for a "one-off" IT project, giving adjusted earnings of $2,500,000.
Diligence dismantled two of them. Restructuring costs had appeared in each of the last four years, averaging around $500,000, and the IT project turned out to be an annual software licence renewal dressed up as a capital initiative. The buyer accepted the legal fees, the salary adjustment and $100,000 of genuinely exceptional restructuring, giving adjusted earnings of $1,200,000 + $250,000 + $300,000 + $100,000 = $1,850,000.
At the six times multiple both sides had been working to, the disputed $650,000 of adjustments was worth 6 x $650,000 = $3,900,000. The fictional deal settled at 6 x $2,000,000 = $12,000,000 with part of the price deferred into an earn-out, so the seller could still be paid for the improvement if the restructuring really did stop. The illustrative point is that adjusted earnings is a negotiating position as much as a measurement, and every add-back should survive being asked about three years running.
Watch out
Common mistakes
- Treating adjusted earnings as a regulated, comparable measure, when there is no standard definition and two companies in the same sector can calculate it very differently.
- Adding back costs that recur every year, such as annual restructuring or perpetual acquisition fees, which simply overstates the sustainable profit.
- Adjusting for one-off losses while leaving one-off gains untouched, which quietly inflates the result and destroys the credibility of the whole schedule.
Questions
People also ask
Is adjusted earnings the same as EBITDA?
No, EBITDA removes interest, tax, depreciation and amortisation regardless of whether they recur, while adjusted earnings removes items judged unrepresentative, and many companies apply both at once.
Why do regulators dislike these figures?
Because they are unaudited and chosen by management, so listed companies are generally required to show the reported figure with equal prominence and reconcile the adjusted number back to it.
How should a buyer verify add-backs?
By asking for supporting invoices, contracts and several years of history for each item, since an adjustment that cannot be evidenced should not be paid for.