What it means
When companies report profit, the official figure follows accounting standards such as US GAAP or IFRS (the rule books for financial statements). Management often feels that the official number is distorted by events that do not reflect everyday trading.
Examples include restructuring costs, merger expenses, legal settlements and write-downs of assets. To give a clearer view, the company presents a second set of figures that leave these out.
The headline might say that earnings per share were $1.35 excluding items, compared with $1.20 on a reported basis. The items removed are listed in a reconciliation table (a schedule showing how one number turns into the other).
Investors often value the adjusted figure because it is more comparable from one period to the next. A company that closed three plants in one year would otherwise look very weak against the previous year.
Analysts usually build their forecasts on the adjusted basis, so companies are judged by how they compare with those expectations. The risk is that management has discretion over what to exclude.
Costs that appear every year, such as share-based pay or restructuring, may be removed because they are labelled as one-off, which can flatter the result. Regulators in many countries require a clear reconciliation to the official figure and expect that the official number is shown with at least equal prominence.
The sensible approach is to look at both numbers and ask what has been excluded and why. Check whether the same type of item appears in several years in a row.
If the gap between adjusted and reported profit is large and persistent, the adjusted number may be hiding genuine costs of running the business. Managers also use adjusted figures internally, for example when setting bonus targets.
If bonuses depend on the adjusted number, there is an incentive to widen the list of exclusions. Boards and audit committees should therefore approve the definition in advance and apply it consistently from year to year.
In practice
Real-world examples.
Example
A retailer announces quarterly profit of $0.60 per share, or $0.72 excluding items. The difference comes from the cost of closing stores. Analysts note that closures have occurred in each of the last three quarters.
Example
A pharmaceutical company reports a large write-down after a trial fails. The press release highlights earnings excluding that charge. The audit committee asks management to explain why the charge is unusual.
Example
A software company excludes the cost of share-based pay from its adjusted results. The CFO argues that the cost is non-cash and varies with the share price. A critic points out that employees are still paid in shares, which dilutes existing owners.
Formula
Calculation
Adjusted earnings per share = (Net income + After-tax excluded costs - After-tax excluded gains) / Shares in issue
Suppose a company reports net income of $12,000,000 and has 10,000,000 shares in issue. Included in that figure are a $3,000,000 restructuring charge before tax and a $1,000,000 gain on selling a building before tax. Assume a tax rate of 25%.
After-tax restructuring cost = $3,000,000 x (1 - 0.25) = $2,250,000. After-tax gain = $1,000,000 x (1 - 0.25) = $750,000.
Adjusted net income = $12,000,000 + $2,250,000 - $750,000 = $13,500,000, so adjusted earnings per share = $13,500,000 / 10,000,000 = $1.35. Reported earnings per share are $12,000,000 / 10,000,000 = $1.20.Case study
Seen in the real world.
Cobalt Ridge Industries is a fictional manufacturer that reported a drop in profit after buying a competitor. Acquisition costs, one-off integration expenses and a write-down of an old brand reduced net income by $18 million.
The finance team published results both ways. The reported profit was $42 million, while earnings excluding items were $60 million, and the press release included a detailed table showing every adjustment.
In this illustrative case, some analysts accepted the explanation, but others pointed out that integration costs would continue for another two years. The CFO agreed to give a forecast of future integration spending, which improved trust, and promised that the same definition of excluded items would be used in every quarter of the following year. The company also committed to describing any new exclusion clearly before using it.
Watch out
Common mistakes.
- Treating adjusted earnings as the official profit, when they are not defined by accounting standards.
- Accepting every exclusion at face value, when some items recur every year and belong in normal costs.
- Comparing one company's adjusted figure with another's, when each firm chooses its own exclusions.
Questions
People also ask.
Why do companies exclude items?
They want to show the underlying performance of the business without the distortion of unusual events. This helps investors compare periods and set expectations.
Is excluding items allowed?
It is generally allowed if the company discloses the adjustments and reconciles them to the official figure, but local securities regulators set rules on presentation.
How should I check whether the exclusions are fair?
Look at how often similar items appear, how large they are compared with profit and whether the company explains them clearly.
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