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Adjusted average sales

What Is Adjusted Average Sales?

Adjusted average sales refer to a financial metric where a company's reported sales revenue has been modified from its raw, or "GAAP," form to present an alternative view of its core business performance. These adjustments aim to exclude items that management considers non-recurring, non-operational, or distorting to provide a clearer picture of underlying trends. While not governed by strict accounting standards like Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS), adjusted average sales are a common type of Non-GAAP measures used in financial reporting to complement official financial statements. Companies often present adjusted average sales to highlight their operational efficiency and long-term potential, believing that unadjusted figures might obscure their true profitability.

History and Origin

The practice of presenting financial metrics beyond strict accounting principles gained significant traction in the 1990s, particularly among technology companies, as they sought to communicate their unique business models and growth prospects to investors. The drive for "pro forma" or "adjusted" figures intensified during the dot-com boom, where traditional revenue recognition methods sometimes struggled to capture the economic reality of new business models.

Over time, the use of adjusted figures became widespread across various industries. Regulators, including the U.S. Securities and Exchange Commission (SEC), began to express concerns about the potential for these non-GAAP measures to mislead investors. In response, the SEC issued "Cautionary Advice" in 2001, followed by the adoption of Regulation G and amendments to Item 10(e) of Regulation S-K in 2003, which mandated specific disclosure requirements for companies using non-GAAP financial measures. These rules require reconciliation to the most directly comparable GAAP measure and prohibit presenting non-GAAP measures with greater prominence than GAAP figures7.

Simultaneously, accounting standard-setters like the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) worked to converge and improve traditional accounting principles. Their joint effort led to the issuance of Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which standardized how companies recognize revenue from contracts with customers. This new guidance, effective for public companies for fiscal years beginning after December 15, 2017, aimed to provide a more robust framework for revenue recognition, reducing inconsistencies that previously necessitated numerous company-specific adjustments6. Despite these efforts, adjusted average sales and other non-GAAP metrics continue to be widely used by companies to tell their financial story.

Key Takeaways

  • Adjusted average sales are non-GAAP financial measures used by companies to present a modified view of their sales revenue, often excluding specific items.
  • These adjustments are intended to provide insights into a company's core operational performance and recurring sales trends, aiding investor analysis.
  • Common adjustments include the removal of revenue from acquisitions or divestitures, currency fluctuations, or non-recurring contractual elements.
  • Unlike GAAP figures, there is no standardized calculation for adjusted average sales, leading to variability in presentation across companies.
  • While useful for analytical purposes, users of financial information should scrutinize the nature of these adjustments and reconcile them to GAAP figures to avoid misinterpretation.

Formula and Calculation

Unlike GAAP sales, which are calculated based on stringent revenue recognition principles, there is no universal formula for adjusted average sales. The "adjustment" itself is at the discretion of management, typically based on what they believe provides a more representative view of ongoing operations. However, a conceptual representation can be formulated as follows:

Adjusted Average Sales=Reported Sales Revenue±Adjustments\text{Adjusted Average Sales} = \text{Reported Sales Revenue} \pm \text{Adjustments}

Where:

  • Reported Sales Revenue: The total revenue reported on the company's income statement in accordance with GAAP or IFRS.
  • Adjustments: These can vary widely but commonly include:
    • Impact of Acquisitions and Divestitures: Adding back or subtracting sales from newly acquired or recently sold business units to show comparable sales from existing operations.
    • Foreign Currency Fluctuations: Removing the impact of currency exchange rate changes to present sales on a constant currency basis.
    • Non-recurring Items: Excluding sales or deferrals related to one-time contracts, significant rebates, or other unusual events.

The exact nature of these adjustments is usually detailed in footnotes to the financial statements or in accompanying investor presentations.

Interpreting the Adjusted Average Sales

Interpreting adjusted average sales requires a critical approach, as the figure is not standardized and its utility depends entirely on the rationale and consistency of the adjustments made. When evaluating adjusted average sales, the primary goal is to understand what management considers its "core" or "organic" sales performance. For instance, if a company has made several large acquisitions or sold off significant parts of its business, adjusting sales to exclude these impacts can provide a clearer view of the growth or decline in its existing, ongoing operations. This "organic" growth figure can be more indicative of the underlying strength of the company's products or services and its ability to attract and retain customers, separate from the effects of corporate transactions.

Users should compare adjusted average sales over multiple periods to identify trends and assess management's consistency in applying adjustments. It is also crucial to compare the adjusted figure with the reported GAAP sales revenue to understand the magnitude and nature of the adjustments. Significant discrepancies should prompt further investigation into the items being excluded. This comparison can help stakeholders assess the long-term profitability and sustainability of the business.

Hypothetical Example

Consider "Tech Innovations Inc.," a software company that reported $500 million in sales revenue for the fiscal year. During the year, the company acquired a smaller competitor, "Data Solutions LLC," which contributed $50 million in sales since the acquisition date. Additionally, Tech Innovations Inc. had a one-time deferred revenue adjustment of $10 million from a legacy contract that was fully recognized this year, which management considers non-recurring for future periods.

To calculate its adjusted average sales for the year, Tech Innovations Inc. might perform the following:

  1. Start with Reported Sales Revenue: $500 million
  2. Adjust for Acquisition: To show sales from its existing operations, Tech Innovations Inc. might subtract the sales contributed by Data Solutions LLC, as these were not part of the original business base for the full year. This could be relevant if comparing year-over-year organic growth.
    • $500 million (Reported Sales) - $50 million (Acquired Sales) = $450 million
  3. Adjust for One-Time Revenue Recognition: Management views the $10 million deferred revenue recognition as a one-time event that won't recur in the same manner. To present a more "normalized" sales figure, they might exclude it.
    • $450 million - $10 million (One-Time Deferred Revenue) = $440 million

In this hypothetical scenario, Tech Innovations Inc. might present "Adjusted Average Sales" of $440 million, alongside its GAAP sales revenue of $500 million, explaining the adjustments made. This helps investors understand what sales are expected from ongoing operations without the specific impacts of recent acquisitions or one-off accounting treatments.

Practical Applications

Adjusted average sales find various practical applications across financial analysis, particularly when standard GAAP figures might not fully convey a company's underlying operational trends or comparative performance.

  • Investment Analysis: Investors and analysts frequently use adjusted average sales to evaluate a company's "organic growth" rate, which excludes the impact of mergers, acquisitions, and currency fluctuations. This allows for a more "apples-to-apples" comparison of a company's sales performance over time and against competitors, particularly those operating in different geographical markets or undergoing significant corporate restructuring. This focus on underlying business strength can inform investment decisions related to long-term value.
  • Management Performance Evaluation: Corporate management often sets targets based on adjusted average sales metrics, as these figures are perceived to better reflect operational achievements within their control, rather than external factors like currency swings or the temporary boost from an acquisition. This aligns performance incentives with core business growth.
  • Credit Analysis: Lenders and credit rating agencies may consider adjusted average sales when assessing a company's ability to generate stable cash flow and service its debt. By stripping out volatile or non-recurring revenue, they can get a clearer picture of the borrower's fundamental capacity to generate sustained earnings.
  • Regulatory Scrutiny: While companies are permitted to disclose Non-GAAP measures, they are subject to SEC filings requirements. The SEC continuously monitors the use of these metrics to ensure they are not misleading and that appropriate reconciliations to GAAP figures are provided. The SEC's regulations stipulate that companies must present the most directly comparable GAAP measure with equal or greater prominence5. This oversight aims to protect investors and maintain transparency in public companies' financial communications.

Limitations and Criticisms

Despite their intended utility, adjusted average sales, like other Non-GAAP measures, face significant limitations and criticisms. The primary concern stems from the lack of standardization, which means companies have considerable discretion in determining what constitutes an "adjustment." This flexibility can lead to inconsistencies not only between different companies but sometimes within the same company across reporting periods, making historical comparisons challenging4.

Critics argue that management might be tempted to "cherry-pick" adjustments, excluding expenses or revenue items that portray the company in a less favorable light while retaining those that inflate the adjusted figures. For example, a company might consistently exclude operating expenses related to stock-based compensation or restructuring charges, arguing they are non-cash or non-recurring, even if they are a regular part of doing business3. This practice can create a misleading perception of profitability or sales growth that is not fully supported by the underlying accrual accounting principles.

Furthermore, adjusted average sales may obscure critical information necessary for a comprehensive understanding of a company's overall financial performance. Investors relying solely on adjusted figures might overlook persistent underlying costs or the true impact of strategic decisions like acquisitions and divestitures on the entire business. Academic research has highlighted that while some non-GAAP exclusions can enhance earnings informativeness, others, particularly those excluding recurring items, can be of "lowest quality" and potentially mislead investors2,1. Therefore, financial analysis should always begin with the comprehensive figures presented in the GAAP income statement and proceed cautiously with any adjusted metrics.

Adjusted Average Sales vs. Reported Sales

The fundamental difference between adjusted average sales and reported sales lies in their adherence to formal accounting standards. Reported sales, also known as GAAP sales, represent the total sales revenue recognized by a company strictly in accordance with either Generally Accepted Accounting Principles (GAAP) or International Financial Reporting Standards (IFRS). These figures are verifiable, auditable, and subject to standardized revenue recognition rules, such as the five-step model under ASC 606, which dictates when and how revenue from performance obligations is recognized. Reported sales aim to provide a consistent and comparable measure across all companies under the same accounting framework.

In contrast, adjusted average sales are a Non-GAAP measures that are not governed by these official accounting standards. They are customized by company management to exclude or include specific items that they believe distort the underlying operational trends. Common adjustments might remove the impact of currency fluctuations, sales from recent acquisitions or divestitures, or other non-recurring items. While intended to offer a clearer view of core business performance, the flexibility in their calculation can lead to a lack of comparability between companies and a potential for bias. Investors often refer to reported sales as the foundational metric, while adjusted average sales serve as a supplementary, management-provided perspective.

FAQs

Why do companies use adjusted average sales if they are not GAAP?

Companies use adjusted average sales to provide a clearer, often more favorable, view of their underlying operational performance and growth trends. They argue that certain items, such as the impact of acquisitions or significant currency swings, can obscure the true performance of the core business, and adjusted figures help investors focus on what management believes is sustainable profitability.

Are adjusted average sales audited?

While the underlying GAAP sales revenue figures are audited as part of the company's full financial statements, the specific calculations and rationale for adjusted average sales are typically not subject to the same level of independent audit scrutiny. However, public companies are required to reconcile non-GAAP measures to their GAAP equivalents in SEC filings, and these disclosures are subject to regulatory oversight.

How can I verify adjusted average sales figures?

To verify adjusted average sales figures, always compare them to the company's officially reported GAAP sales revenue on its income statement. Companies are generally required to provide a reconciliation of the adjusted figures to the most comparable GAAP measure, explaining each adjustment. This reconciliation is usually found in earnings releases, investor presentations, or regulatory filings like Form 10-K or 10-Q.

What are some common items adjusted in sales?

Common items adjusted in sales figures include the impact of foreign currency fluctuations (to show constant currency sales), the contribution from recently acquired or divested businesses (to show organic sales growth), and the effects of specific non-recurring contracts or revenue deferrals. The goal is often to isolate sales performance stemming from ongoing, core operations.