Adjusted average roa: Meaning, Criticisms & Real-World Uses

What Is Adjusted Average ROA?

Adjusted Average ROA refers to a modified version of the Return on Assets (ROA) financial ratio, designed to provide a more refined view of a company's profitability relative to its total assets. While traditional ROA uses reported net income, Adjusted Average ROA typically modifies this income figure by excluding certain non-recurring, unusual, or non-operating items that may distort a company's core financial performance. This adjustment falls under the broader category of Financial Ratios, which are analytical tools used to assess a company's financial health and operational efficiency. The goal of using an adjusted average ROA is to present a clearer picture of a company's true earning power from its assets, removing the noise from one-off events.

History and Origin

The concept of "adjusted" financial metrics, including Adjusted Average ROA, evolved as companies and analysts sought to provide or obtain a clearer picture of ongoing business operations, often beyond what is strictly presented under Generally Accepted Accounting Principles (GAAP). While GAAP aims for comparability and consistency in financial reporting, it sometimes includes items that are not reflective of a company's sustainable earnings. Over time, companies began to report what are known as non-GAAP measures to supplement their official financial statements.

This practice gained significant traction, leading to increased regulatory scrutiny. In response to concerns about potentially misleading presentations, the U.S. Securities and Exchange Commission (SEC) issued updated guidance in May 2016 regarding the use of non-GAAP financial measures. This guidance aimed to help companies avoid presenting financial information in an improper or potentially misleading manner, emphasizing that non-GAAP measures should not be given greater prominence than comparable GAAP measures and should be clearly reconciled.⁵ The Financial Accounting Standards Board (FASB) also provides a Conceptual Framework for Financial Reporting which emphasizes qualitative characteristics such as comparability, which underpins the desire for "adjusted" metrics that allow for better comparison of core operational performance.⁴

Key Takeaways

Adjusted Average ROA offers a refined measure of a company's efficiency in generating profit from its assets.
It typically excludes one-time gains or losses, or non-operating items, from the net income calculation.
This metric aims to provide a more accurate view of sustainable core profitability.
Analysts and investors use Adjusted Average ROA to compare companies and assess operational effectiveness.
Care must be taken to understand the adjustments made, as they are often subjective and vary between companies.

Formula and Calculation

The formula for Adjusted Average ROA begins with the basic Return on Assets calculation, then modifies the numerator to reflect the "adjusted" net income.

The base ROA formula is:

\text{ROA} = \frac{\text{Net Income}}{\text{Average Total Assets}}

For Adjusted Average ROA, the formula becomes:

\text{Adjusted Average ROA} = \frac{\text{Net Income} \pm \text{Adjustments}}{\text{Average Total Assets}}

Where:

Net Income: The profit remaining after all expenses, taxes, and interest have been deducted from revenue, typically found on the income statement.
Adjustments: These are specific non-recurring or non-operating items added back or subtracted from net income. Common adjustments might include:
- One-time gains or losses (e.g., from the sale of a division or asset).
- Restructuring charges.
- Impairment charges.
- Unusual legal settlements.
- Non-cash expenses like certain amortization or depreciation, if deemed distortive to operational cash flow.
Average Total Assets: The average value of a company's total assets over a period, typically calculated as (Beginning Assets + Ending Assets) / 2. This figure is derived from the balance sheet.

Interpreting the Adjusted Average ROA

Interpreting the Adjusted Average ROA involves understanding what the adjusted figure reveals about a company's fundamental asset management capabilities. A higher Adjusted Average ROA generally indicates that a company is more effectively utilizing its assets to generate core profits, free from the influence of one-off events. This makes it a valuable metric for assessing a company's operational efficiency and its ability to consistently turn its asset base into earnings.

Analysts often use this adjusted metric to compare companies within the same industry, as it helps standardize profitability measures by removing idiosyncratic events that might affect one company but not another. It allows for a "cleaner" comparison of how well management is deploying capital to generate revenue and profit from ongoing operations. Investors might look for a stable or improving Adjusted Average ROA as a sign of consistent underlying business health.

Hypothetical Example

Consider two hypothetical companies, Alpha Corp and Beta Inc., operating in the same industry.

Alpha Corp's Financials (Year 1):

Net Income: $10 million
Average Total Assets: $100 million
Special Adjustment: Included a one-time gain of $2 million from selling a non-core division.

Beta Inc.'s Financials (Year 1):

Net Income: $8 million
Average Total Assets: $80 million
Special Adjustment: None.

First, calculate the unadjusted ROA for both:

Alpha Corp ROA = $10 million / $100 million = 10%
Beta Inc. ROA = $8 million / $80 million = 10%

At first glance, both companies appear to have the same profitability relative to their assets. However, using Adjusted Average ROA:

For Alpha Corp, we adjust its net income by removing the one-time gain:

Adjusted Net Income (Alpha Corp) = $10 million - $2 million = $8 million
Adjusted Average ROA (Alpha Corp) = $8 million / $100 million = 8%

For Beta Inc., no adjustments are needed, so its Adjusted Average ROA remains 10%.

This hypothetical example illustrates that while their nominal ROA was identical, Alpha Corp's core operational profitability, as revealed by the Adjusted Average ROA, was actually lower than Beta Inc.'s. This deeper insight helps investors and shareholders make more informed decisions by focusing on sustainable earning power rather than temporary events.

Practical Applications

Adjusted Average ROA is commonly applied in several areas of finance and investment analysis to gain a clearer perspective on a company's core financial health and operating efficiency.

Equity Analysis: Equity analysts frequently use adjusted metrics to evaluate a company's underlying earnings power, which is critical for forecasting future earnings per share (EPS) and valuation. By stripping out volatile or non-recurring items, they can better assess the quality of earnings and the sustainability of a company's profitability.
Credit Analysis: Creditors and rating agencies may use Adjusted Average ROA to evaluate a company's ability to generate cash from its assets consistently to service debt. A stable or improving adjusted ROA can indicate a stronger capacity for debt repayment.
Internal Management: Company management often tracks adjusted versions of performance metrics, including ROA, to evaluate the effectiveness of strategic initiatives and operational improvements, without the distortion of external, non-operating factors. This helps in making better internal resource allocation decisions.
Industry Benchmarking: Given that some industries are prone to specific one-off events (e.g., legal settlements, asset sales), adjusted ROA can facilitate more meaningful comparisons between competitors. For instance, in the banking sector, profitability as measured by Return on Average Assets (ROAA) can be influenced by nonrecurring expenses, as noted by the Federal Reserve.³ Similarly, large corporations like Thomson Reuters often report "adjusted EBITDA" and "adjusted EPS" in their earnings releases to provide insights into their underlying operational performance, beyond the unadjusted GAAP figures.²

Limitations and Criticisms

While Adjusted Average ROA provides valuable insights, it is important to acknowledge its limitations and potential criticisms.

Subjectivity of Adjustments: The primary criticism stems from the subjective nature of the adjustments made. What one company or analyst considers "non-recurring" or "non-operating" might be viewed differently by another. This lack of standardization can reduce comparability across different companies, even when they both present an "adjusted" ROA. There is a risk that companies might selectively remove expenses to inflate their perceived financial performance, a practice that has historically drawn regulatory scrutiny from bodies like the SEC.¹
Potential for Misleading Information: If adjustments are not clearly disclosed and consistently applied, or if they are used to obscure recurring operational costs, Adjusted Average ROA can be misleading. Investors should always refer back to the Generally Accepted Accounting Principles (GAAP) figures and the reconciliation statements provided by companies to understand the nature of all adjustments.
Loss of Comprehensive View: Focusing solely on adjusted metrics can lead to overlooking the full financial picture. While one-time events may not reflect core operations, they are still real economic events that impact a company's overall cash flow and financial health.
Lack of Audit Standard: Unlike GAAP figures, which are subject to rigorous auditing standards, the calculation of Adjusted Average ROA and other non-GAAP measures is not directly subject to the same level of independent verification. This places a greater burden on investors and analysts to scrutinize the adjustments made.

Adjusted Average ROA vs. Return on Assets (ROA)

The core difference between Adjusted Average ROA and traditional Return on Assets (ROA) lies in the treatment of the "Net Income" component.

Feature	Return on Assets (ROA)	Adjusted Average ROA
Net Income Used	Reported net income from the income statement, as per Generally Accepted Accounting Principles (GAAP).	Modified net income, where certain non-recurring, unusual, or non-operating items are added back or subtracted.
Purpose	Measures overall profitability relative to assets, including all gains and losses.	Aims to highlight core operational financial performance by excluding distortions from one-off events.
Comparability	Direct comparability across companies if all adhere to GAAP, but can be skewed by unique events.	Improved comparability for core operations between companies, but dependent on the consistency and transparency of adjustments.
Transparency/Audit	Subject to auditing standards and regulatory oversight.	Less regulated; adjustments are at management's discretion (though often reconciled to GAAP).

In essence, ROA provides a comprehensive view of a company's overall earnings from its total assets, including all financial events. Adjusted Average ROA attempts to filter out specific events to provide a normalized view of a company's ongoing operational efficiency. The two metrics serve different but complementary purposes in a thorough financial analysis.

FAQs

Why do companies report Adjusted Average ROA?

Companies report Adjusted Average ROA and other adjusted metrics to provide investors and analysts with a clearer view of their underlying operational financial performance. They believe that certain one-time events or non-operating items can distort the true picture of their core business, making comparisons over time or with competitors less meaningful.

Is Adjusted Average ROA a GAAP measure?

No, Adjusted Average ROA is a non-GAAP measure. It is not calculated according to the rules set forth by Generally Accepted Accounting Principles (GAAP). Companies that report non-GAAP measures are typically required to reconcile them to the most directly comparable GAAP measure and explain the adjustments made.

What kind of adjustments are typically made for Adjusted Average ROA?

Common adjustments include adding back or subtracting non-recurring gains or losses (such as proceeds from the sale of an asset or business segment), restructuring charges, impairment charges, significant legal settlements, or other unusual items that are not expected to recur in the normal course of business. The goal is to isolate the profit generated from ongoing operations.

How does Adjusted Average ROA help investors?

Adjusted Average ROA helps investors by providing a more consistent and comparable metric for evaluating a company's core profitability from its assets. It can help assess the sustainability of earnings and the efficiency of asset management, which are key factors in investment decision-making.

Can Adjusted Average ROA be misleading?

Yes, Adjusted Average ROA can be misleading if the adjustments are not transparent, consistently applied, or are used to mask recurring operational costs as "non-recurring." Investors should always examine the reconciliation to net income and understand the nature of each adjustment before relying solely on the adjusted figure.