The Adjusted Number a Company Would Prefer You Used
Companies present earnings measures that exclude items they consider unrepresentative, alongside the audited figures. The practice is regulated, widely used, and the exclusions are almost always in the same direction.
Why They Exist at All
Audited financial statements follow rules designed for consistency across every company in the economy. Those rules necessarily include items that a particular business considers unrepresentative of its ongoing operations: a legal settlement, the accounting effects of an acquisition, a facility closure, a currency movement on a foreign subsidiary.
Management argues, frequently with justification, that an investor trying to model future earnings is better served by a measure excluding items unlikely to recur. That is the honest case for non GAAP measures, and it is a real case.
The most common are adjusted earnings, adjusted EBITDA, free cash flow, organic revenue growth, and constant currency revenue.
The Rules That Constrain Them
Because the potential for misuse is obvious, presentation is regulated rather than free.
| Requirement | Purpose |
|---|---|
| Reconciliation to the nearest audited measure | Show exactly what was excluded |
| Equal or greater prominence for the audited figure | Prevent the adjusted number leading |
| No misleading measures | Bars exclusions that distort |
| Consistency across periods | Prevents changing the definition to suit results |
| No individually tailored recognition | Bars rewriting revenue rules |
The last item is the sharpest and least known. A company may not present a measure that applies its own revenue recognition method, such as showing revenue as though it were recognised at the point of sale when the standards require it over time. Adjusting for an expense is permitted; rewriting when revenue exists is not.
The regulator objection is almost never to a specific exclusion. It is to a pattern in which the exclusions are consistently unfavourable items, the definition shifts when it is convenient, and the adjusted figure appears first, largest, and in the headline.
The Exclusions Worth Arguing About
Stock based compensation is the largest and most contested. It is a genuine cost of employing people, settled in shares rather than cash, and excluding it presents a company as more profitable than it is while shareholders bear the dilution. It is also non cash and lumpy. The consensus among analysts has moved decisively toward treating it as a real expense, and companies excluding it are increasingly asked to justify doing so.
Restructuring charges are defensible when genuinely one time. A company that has reported restructuring charges in each of the last eight years is describing an ordinary cost of operating, not an exception, and the pattern is easy to check.
Acquisition related amortisation is excluded on the argument that it reflects purchase accounting rather than economic cost. That is reasonable for a company that acquires rarely. For a serial acquirer whose growth depends on purchasing businesses, the amortisation is the recurring cost of the growth strategy.
Litigation settlements are one time individually and recurring in aggregate for companies in litigation heavy industries.
The Asymmetry
The most damning empirical observation about the practice is directional. Studies of adjustment patterns consistently find that exclusions skew toward removing expenses rather than removing gains, and that adjusted figures exceed audited figures far more often than they fall below them.
If adjustments removed genuine noise, they would be roughly symmetric, since unrepresentative items should occur in both directions. The observed asymmetry indicates that the selection of what counts as unrepresentative is influenced by whether the item helps.
That does not make any individual adjustment wrong. It does mean the aggregate practice deserves scepticism that individual justifications do not address.
The Compensation Link
A structural reason these measures matter beyond presentation is that executive compensation is frequently tied to them. A bonus based on adjusted earnings, where management influences the definition of adjusted, contains an obvious circularity.
Compensation committees address this by fixing the definition in advance and requiring board approval for changes, and proxy advisers scrutinise the gap between adjusted results used for compensation and audited results. A company paying substantial bonuses on adjusted earnings in a year of audited losses is a recognisable governance flag.
How to Use Them Sensibly
The practical approach is not to reject these measures, which would discard genuinely useful information, but to interrogate them.
Read the reconciliation rather than the headline. Track the same exclusion across five years and see whether it recurs. Compare the adjusted figure against operating cash flow, since cash is indifferent to the definition. Note whether the definition has changed and whether prior periods were restated to match. And check whether the exclusions would have been made if they had been gains.
The Bottom Line
Non standard earnings measures address a real limitation in standardised accounting and are used, in aggregate, in a consistently favourable direction. The regulatory framework requires reconciliation and equal prominence precisely because the disclosure is what makes the measure usable. An adjusted figure with a clear reconciliation and stable definitions is informative; the same figure with shifting exclusions that all happen to be costs is a marketing document with an income statement attached.