Adjusted cash growth rate: Meaning, Criticisms & Real-World Uses

What Is Adjusted Cash Growth Rate?

The Adjusted Cash Growth Rate is a financial metric that measures the rate at which a company's available cash, after certain non-operating or extraordinary items have been accounted for, increases over a period. This metric falls under the broader umbrella of financial analysis, providing insights into a company's true cash-generating capabilities beyond standard reported figures. Unlike simpler measures of cash flow, the Adjusted Cash Growth Rate aims to refine the raw cash flow data, often by excluding non-recurring events, significant capital outlays, or other items that might distort a clear picture of sustainable cash generation from core operations. It is particularly useful for assessing a firm's liquidity and its capacity to fund future growth, pay down debt, or distribute value to shareholders.

History and Origin

The concept of analyzing a company's cash generation has evolved significantly over time. While summaries of cash receipts and disbursements date back to the 19th century with companies like Northern Central Railroad in 1863, the formalization of cash flow reporting for all business enterprises in the United States began much later. Prior to 1987, the statement of changes in financial position often focused on working capital changes, but the Financial Accounting Standards Board (FASB) recognized the increasing importance of direct cash flow information. In November 1987, FASB issued Statement No. 95, titled "Statement of Cash Flows," which superseded previous guidance and mandated the inclusion of a cash flow statement as part of a full set of financial statements. This pivotal standard required cash receipts and payments to be classified into operating activities, investing activities, and financing activities.⁹

The move towards more granular cash flow analysis laid the groundwork for specialized, non-standard metrics like the Adjusted Cash Growth Rate. As investors and analysts sought deeper insights beyond mandated GAAP (Generally Accepted Accounting Principles) figures, various non-GAAP measures emerged to provide a more tailored view of a company's underlying performance. These adjusted metrics became prevalent as a way to normalize for specific events or accounting treatments that might obscure the recurring strength of a company's cash generation. The Securities and Exchange Commission (SEC) has since provided extensive guidance regarding the disclosure and reconciliation of such non-GAAP financial measures to ensure transparency and prevent misleading presentations.⁸

Key Takeaways

The Adjusted Cash Growth Rate provides a refined view of a company's increase in available cash, often by normalizing for non-recurring or non-operating items.
It offers a crucial perspective on a firm's ability to generate cash from its core business, distinct from accounting net income, which can be influenced by non-cash expenses like depreciation and amortization.
Understanding this metric helps assess a company's financial health, its capacity to fund operations, invest in growth, and return capital to shareholders.
Because it is a non-GAAP measure, careful consideration of its calculation and reconciliation to comparable GAAP figures is essential for proper analysis.
Analyzing the Adjusted Cash Growth Rate over multiple periods reveals trends in a company's sustainable cash-generating capabilities.

Formula and Calculation

The term "Adjusted Cash Growth Rate" does not refer to a single, universally standardized formula, as the specific "adjustments" can vary depending on the analytical purpose or the industry. However, it generally involves taking a base cash flow figure, often cash flow from operations or free cash flow, and then modifying it for specific items deemed non-recurring, extraordinary, or distorting to core business performance.

A generalized approach to calculating a form of Adjusted Cash Growth Rate could be:

Calculate Adjusted Cash Flow for Period 1 (ACF1):
$ACF_1 = CFO_1 - \text{Non-recurring Inflows}_1 + \text{Non-recurring Outflows}_1$
Where:
- (CFO_1) = Cash Flow from Operations for Period 1
- (\text{Non-recurring Inflows}_1) = Cash inflows that are not expected to repeat (e.g., proceeds from a one-time asset sale unrelated to core business, large insurance settlements).
- (\text{Non-recurring Outflows}_1) = Cash outflows that are not expected to repeat (e.g., one-time legal settlements, restructuring costs paid in cash, significant unusual capital expenditures not part of regular growth strategy).
Calculate Adjusted Cash Flow for Period 2 (ACF2):
Apply the same adjustment methodology for the subsequent period:
$ACF_2 = CFO_2 - \text{Non-recurring Inflows}_2 + \text{Non-recurring Outflows}_2$
Calculate Adjusted Cash Growth Rate:
$\text{Adjusted Cash Growth Rate} = \frac{ACF_2 - ACF_1}{ACF_1} \times 100\%$

Analysts might define "non-recurring" differently based on their objectives, focusing on items that would otherwise obscure the sustainable operating profitability and cash generation capacity of the business.

Interpreting the Adjusted Cash Growth Rate

Interpreting the Adjusted Cash Growth Rate involves understanding what the "adjustment" aims to achieve and then evaluating the trend and magnitude of the resulting growth. A positive Adjusted Cash Growth Rate indicates that a company's sustainable cash-generating ability is increasing, which is generally a favorable sign for financial health. This suggests the company is becoming more efficient at converting its operations into cash, or its underlying business is growing.⁷

Conversely, a negative or declining Adjusted Cash Growth Rate could signal underlying issues. It might suggest that while reported revenues or net income appear stable, the core cash conversion is deteriorating. This could be due to slower collections from customers, increasing operating expenses, or other factors affecting the company's ability to generate ready cash. A thorough financial analysis would delve into the components of the cash flow statement to pinpoint the reasons behind such trends. Investors and management use this metric to evaluate whether a company can generate enough cash to meet short-term obligations and fund future growth, highlighting its liquidity and solvency.⁶

Hypothetical Example

Consider "Tech Innovations Inc.," a software company, that wants to assess its sustainable cash generation. The CFO decides to calculate the Adjusted Cash Growth Rate by normalizing for the one-time sale of a non-core patent in 2023 and unusual legal settlement payments made in 2024.

2023 Financial Data (Period 1):

Cash Flow from Operations (CFO): $15,000,000
Proceeds from Patent Sale (non-recurring inflow): $2,000,000

2024 Financial Data (Period 2):

Cash Flow from Operations (CFO): $17,000,000
Legal Settlement Payments (non-recurring outflow): $1,500,000

Step 1: Calculate Adjusted Cash Flow for 2023 (ACF1)
To get a clearer picture of cash generated from regular operations, the non-recurring patent sale proceeds are removed.

ACF_{2023} = CFO_{2023} - \text{Proceeds from Patent Sale}

ACF_{2023} = \$15,000,000 - \$2,000,000 = \$13,000,000

Step 2: Calculate Adjusted Cash Flow for 2024 (ACF2)
The non-recurring legal settlement payment is added back to reflect the underlying operational cash flow without this extraordinary expense.

ACF_{2024} = CFO_{2024} + \text{Legal Settlement Payments}

ACF_{2024} = \$17,000,000 + \$1,500,000 = \$18,500,000

Step 3: Calculate Adjusted Cash Growth Rate

\text{Adjusted Cash Growth Rate} = \frac{ACF_{2024} - ACF_{2023}}{ACF_{2023}} \times 100\%

\text{Adjusted Cash Growth Rate} = \frac{\$18,500,000 - \$13,000,000}{\$13,000,000} \times 100\%

\text{Adjusted Cash Growth Rate} = \frac{\$5,500,000}{\$13,000,000} \times 100\% \approx 42.31\%

In this hypothetical example, Tech Innovations Inc. shows a strong Adjusted Cash Growth Rate of approximately 42.31%, suggesting robust growth in its underlying, recurring cash-generating capabilities, despite the one-time events. This offers a more optimistic and perhaps accurate view of its operational strength than a simple unadjusted cash flow comparison might. A company's balance sheet and income statement would provide additional context for this cash flow performance.

Practical Applications

The Adjusted Cash Growth Rate finds practical applications across various financial disciplines, primarily in areas requiring a deep understanding of a company's sustainable cash generation.

Investment Analysis: Investors utilize this metric to evaluate the quality of a company's earnings and its capacity for future dividend payments or share buybacks. A consistent positive Adjusted Cash Growth Rate often signals a healthy, growing business capable of self-funding its expansion and providing returns to shareholders.
Corporate Finance and Strategic Planning: Within a company, management teams use the Adjusted Cash Growth Rate for budgeting, forecasting, and making strategic decisions about expansion, debt repayment, or acquisitions. It helps determine if internal cash flows are sufficient to meet operational needs and strategic goals without relying excessively on external financing.⁵
Credit Analysis: Lenders and credit rating agencies assess this rate to gauge a borrower's ability to service its debts from recurring cash flows. A strong and growing adjusted cash flow can lead to more favorable lending terms.
Valuation: For analysts performing discounted cash flow (DCF) models, using an adjusted, normalized cash flow figure as the basis for projections can lead to more accurate valuation estimates by removing the noise of extraordinary items.
Performance Measurement: Companies may use a custom-defined Adjusted Cash Growth Rate as an internal key performance indicator (KPI) to track operational efficiency and cash conversion success over time, incentivizing management to focus on sustainable cash generation rather than just reported profits.⁴

This metric is particularly valuable when standard cash flow figures are heavily influenced by unusual events, providing a clearer, "normalized" picture of the business's core financial performance.

Limitations and Criticisms

Despite its utility, the Adjusted Cash Growth Rate, like other non-GAAP measures, comes with inherent limitations and criticisms that necessitate careful consideration.

One primary concern is the subjectivity of adjustments. There is no universal standard for what constitutes a "non-recurring" or "extraordinary" item that should be excluded from a cash flow calculation to arrive at an "adjusted" figure. Companies or analysts might selectively remove expenses or add back revenues in a way that artificially inflates the perceived cash generation, making comparisons between different companies difficult and potentially misleading. The Securities and Exchange Commission (SEC) has provided guidance to curb such practices, emphasizing that non-GAAP measures should not exclude normal, recurring cash operating expenses.², ³

Another limitation is the potential for manipulation or "pro forma" reporting. While the intent may be to provide clearer insight, aggressive adjustments can obscure a company's true operational challenges or recurring costs. This can lead to a divergence between reported net income and cash flow, which can be a red flag for analysts regarding earnings quality.¹

Furthermore, relying solely on an Adjusted Cash Growth Rate without considering other financial statements (like the balance sheet and income statement) or the context of a company's business model can be risky. For instance, a high growth rate might be unsustainable if it is only achieved through aggressive working capital management that cannot be maintained over the long term, or if it overlooks significant, yet recurring, capital expenditures necessary for maintenance or growth.

Analysts and investors must meticulously review the specific adjustments made when an Adjusted Cash Growth Rate is presented, understanding the rationale behind each and assessing whether they genuinely represent non-recurring or non-operational events.

Adjusted Cash Growth Rate vs. Free Cash Flow Growth Rate

While both the Adjusted Cash Growth Rate and the Free Cash Flow Growth Rate are metrics used to assess a company's cash-generating capabilities and their trajectory, they differ primarily in their starting point and the scope of their "adjustments."

Free Cash Flow (FCF) is a standard and widely accepted non-GAAP measure, typically defined as cash flow from operations less capital expenditures. It represents the cash available to a company after paying for expenses and investments necessary to maintain or expand its asset base. The Free Cash Flow Growth Rate, therefore, measures the percentage change in this standardized FCF over a period.

The Adjusted Cash Growth Rate, by contrast, is a more flexible and often more granular metric. While it might start with a base like cash flow from operations or even free cash flow, it then applies additional, often company-specific or analyst-specific, "adjustments." These adjustments typically aim to normalize cash flow by removing the impact of events considered truly extraordinary, non-recurring, or unrelated to core business performance. For instance, an Adjusted Cash Growth Rate might exclude the cash impact of a one-time legal settlement, a large asset impairment, or proceeds from the sale of a non-operating segment that FCF might implicitly include or not specifically isolate.

The key distinction lies in the discretion involved. Free Cash Flow has a more commonly understood and applied definition. The "adjustments" in Adjusted Cash Growth Rate introduce more subjectivity, as what one analyst considers "adjusting" another might view as part of the normal course of business. This flexibility means the Adjusted Cash Growth Rate can offer a highly tailored view, but it also demands greater scrutiny of the specific items adjusted to ensure meaningful comparison and analysis.

FAQs

What does "adjusted" mean in Adjusted Cash Growth Rate?

"Adjusted" refers to the process of modifying a standard cash flow figure, such as cash flow from operations, by adding back or subtracting specific items. These items are typically considered non-recurring, extraordinary, or non-operational, allowing analysts to focus on the sustainable cash generation from a company's core business activities.

Why is Adjusted Cash Growth Rate used instead of just Cash Flow Growth Rate?

The Adjusted Cash Growth Rate is used to provide a clearer, "normalized" view of a company's cash-generating trend. Standard cash flow figures can be skewed by one-time events or unusual transactions. By making adjustments, stakeholders can better assess the underlying financial health and operational profitability without the noise of non-recurring items.

Is Adjusted Cash Growth Rate a GAAP measure?

No, the Adjusted Cash Growth Rate is typically a non-GAAP measure. GAAP (Generally Accepted Accounting Principles) provides strict rules for preparing financial statements, including the Statement of Cash Flows. "Adjusted" metrics are supplementary measures created by companies or analysts to offer additional insights, and they must be clearly reconciled to their closest GAAP equivalent when publicly disclosed.

Can a company have a high Adjusted Cash Growth Rate but low Net Income growth?

Yes, it is possible. Net income includes non-cash expenses like depreciation and amortization, as well as accruals, while cash flow focuses on actual cash inflows and outflows. A company might have strong cash generation from its operations, leading to a high Adjusted Cash Growth Rate, even if non-cash charges or accounting accruals reduce its reported net income growth. This highlights the importance of analyzing both profitability and cash flow metrics.