What it means
Every company has a core business, which is what it does day to day to earn money. A bakery's core activity is making and selling bread, while a software firm's is selling licences or subscriptions.
Anything else that affects profit, such as selling a spare property or paying for a lawsuit, sits outside that core. These items can distort the picture.
If a company sells land at a $2,000,000 gain, its profit jumps, but the gain will not repeat next year. If it pays $1,500,000 to close a factory, profit falls, but the cost is not part of ordinary trading.
To deal with this, companies and analysts present adjusted figures such as adjusted operating profit or underlying earnings. These start with reported profit and remove the non-core items.
The adjusted number is meant to show what the business would have earned without the one-offs. Used carefully, this helps managers and investors compare performance from year to year.
Used carelessly, it can mislead. Some companies label costs as non-core every year, which makes them look recurring, and the adjusted profit becomes flattering.
A useful test is to ask whether the item is unusual and infrequent, and whether it is genuinely unrelated to ordinary operations. If a company reports a "one-off" restructuring charge in five years out of six, it is probably part of the cost of doing business.
Careful readers look at the history before accepting the adjustment. Accounting rules vary on how such items must be shown.
Some require disclosure in the notes, while others allow separate lines on the income statement. Managers preparing adjusted figures should explain each adjustment and apply the same approach every year.
In practice
Real-world examples.
Example
A food manufacturer sells an old warehouse for $3,000,000 more than its book value. The gain appears in profit but is not part of its core food business. Analysts remove it from their view of underlying earnings. The analyst also notes that the sale reduces the property the company owns, which may change its future rent costs.
Example
A software company pays $800,000 to settle a patent dispute. The payment reduces profit for the year but is unlikely to recur. The finance director shows it separately in the adjusted results. Investors accept the adjustment because the dispute has now been settled.
Example
A hotel group records $1,200,000 of costs for closing two unprofitable hotels. The closures are part of a one-time strategy change. Investors compare profit before and after the costs to judge the remaining hotels. They also track whether closure costs appear again in later years.
Formula
Calculation
Adjusted operating profit = reported operating profit + non-core expenses - non-core gains
A company reports operating profit of $5,000,000. It includes a restructuring cost of $600,000 and a gain on the sale of a property of $400,000, both non-core. Adjusted operating profit = 5,000,000 + 600,000 - 400,000 = $5,200,000.Case study
Seen in the real world.
Calloway Stores is a fictional retailer that reported operating profit of $9,000,000. In this illustrative story, the figure included a $2,500,000 gain from selling a distribution centre and a $1,000,000 charge for closing a few stores. Excluding both items, adjusted operating profit was 9,000,000 - 2,500,000 + 1,000,000 = $7,500,000.
An analyst compared this with the previous year's adjusted figure of $8,200,000 and concluded that the core business had weakened. Management had emphasised the higher reported profit, but the underlying trend was down. The board asked for adjusted figures to be reviewed by the audit committee to ensure they were presented fairly.
After the review, Calloway's board agreed a policy on adjusted figures. Each adjustment must be explained in a note, shown for both the current and the previous year, and approved by the audit committee before publication. The chief financial officer said the policy made the reporting less flattering in the short run but improved trust with analysts and lenders, who could now see exactly what had been excluded and why.
Watch out
Common mistakes.
- Labelling recurring costs as non-core. If a cost appears most years, it is part of the normal cost of doing business.
- Excluding losses but keeping gains, or the reverse. Adjustments should apply consistently in both directions.
- Relying on adjusted profit alone. Reported profit and cash flow also show what really happened.
Questions
People also ask.
What is the purpose of excluding non-core items?
To show the performance of the business without distortion from unusual events. It helps managers set fair targets and helps investors compare one year with the next.
Are non-core items the same as extraordinary items?
They are related, but extraordinary items had a stricter accounting definition that many standards no longer allow.
Who decides what is non-core?
Management proposes it, and auditors and analysts review whether it is reasonable. Regulators in some markets also publish guidance on how adjusted measures should be labelled and explained.
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