Adjusted consolidated total return

What Is Adjusted Consolidated Total Return?

Adjusted Consolidated Total Return is a comprehensive metric in the realm of financial reporting and investment performance measurement that quantifies the overall return of an entity or an investment portfolio, taking into account both capital appreciation and income distributions, and then modifying these figures based on specific, non-standard accounting adjustments. This measure aims to provide a more nuanced view of an entity's financial performance by excluding or including certain items that management believes offer a clearer picture of underlying operational results, especially in the context of consolidated financial statements. These adjustments often distinguish it from standard total return calculations by removing elements considered non-recurring, non-cash, or otherwise distorting to ongoing performance.

History and Origin

The concept of "adjusted" financial metrics, including Adjusted Consolidated Total Return, evolved largely in response to the increasing complexity of modern corporate structures and financial transactions. As companies grew through business combinations and acquisitions, and as accounting standards became more intricate, the desire for alternative performance measures beyond strict GAAP (Generally Accepted Accounting Principles) became more pronounced. Companies began to present what are known as non-GAAP measures to highlight performance as they saw fit, often stripping out items like goodwill impairment, acquisition-related costs, or one-time gains and losses. This practice gained significant traction, prompting the U.S. Securities and Exchange Commission (SEC) to issue guidance on the use and disclosure of such non-GAAP financial measures to ensure they do not mislead investors. The SEC has periodically updated its guidance, emphasizing the need for reconciliation to comparable GAAP measures and prohibiting certain adjustments or presentations that could be misleading.⁷,⁶ For example, General Electric's 2021 Annual Report includes a section on "NON-GAAP FINANCIAL MEASURES," explaining why they use them and providing reconciliations to their most directly comparable GAAP financial measures.⁵

Key Takeaways

• Adjusted Consolidated Total Return provides a comprehensive view of an investment's or entity's performance, including capital appreciation and income distributions.
• The "adjusted" component refers to modifications made to standard financial figures, often excluding non-recurring or non-cash items.
• These adjustments are typically "non-GAAP measures," used by management to highlight perceived underlying operational performance.
• Regulators like the SEC provide guidance on the use of adjusted metrics to ensure transparency and prevent misleading presentations.
• It offers insights into shareholder value that might not be immediately apparent from unadjusted figures.

Formula and Calculation

The calculation of Adjusted Consolidated Total Return begins with the standard total return formula, then incorporates specific adjustments. The base total return includes price appreciation (or depreciation) and all forms of income generated by the investment.

The general formula for Total Return is:

Where:

• (\text{Ending Value}) = The market value of the investment at the end of the period.
• (\text{Beginning Value}) = The market value of the investment at the start of the period.
• (\text{Income Distributions}) = All cash or non-cash payments received from the investment during the period, such as dividends, interest income, or capital gains distributions.

To arrive at the Adjusted Consolidated Total Return, the "Income Distributions" and potentially the "Ending Value" or "Beginning Value" (due to revaluations or restatements) are modified by specific adjustments. These adjustments often relate to items that are considered non-operating, non-recurring, or non-cash, such as:

• Acquisition-related costs: Expenses incurred during a business combination.
• Restructuring charges: Costs associated with significant organizational changes.
• Impairment charges: Write-downs of assets, like goodwill.
• Stock-based compensation: Non-cash expenses related to employee compensation.
• Certain tax effects: Adjustments to reflect specific tax treatments.

The precise formula for Adjusted Consolidated Total Return will vary depending on the nature of the adjustments made by the entity or analyst. There is no single universal formula, as the adjustments are specific to the entity and the purpose of the adjusted metric.

Interpreting the Adjusted Consolidated Total Return

Interpreting Adjusted Consolidated Total Return requires a thorough understanding of the specific adjustments made. Unlike standard financial metrics, which adhere to universal accounting standards, "adjusted" figures are often unique to a company's reporting. When evaluating this metric, it is crucial to review the accompanying disclosures that explain what items have been excluded or included and why.

Analysts and investors use Adjusted Consolidated Total Return to gain insights into a company's core operational profitability and the underlying performance of its assets, particularly after significant events like a merger or acquisition, where the acquisition method of accounting can introduce complexities. For example, by removing one-time restructuring charges, an adjusted return might better reflect the ongoing profitability of the combined entity. However, if "adjusted" consistently excludes "normal, recurring cash operating expenses," the measure could be considered misleading by regulators.⁴

Hypothetical Example

Consider a hypothetical conglomerate, "Global Innovations Inc.," which acquired "Tech Solutions Co." a year ago.

• Global Innovations Inc. (Parent):
  • Initial Investment in Tech Solutions: $100 million
  • Market Value of investment in Tech Solutions (after 1 year): $115 million
  • Dividends received from Tech Solutions (distributed to Global Innovations): $2 million
• Adjustments identified by Global Innovations' management:
  • One-time integration costs (related to acquisition): $3 million (non-cash impairment of certain legacy Tech Solutions software)
  • Unusual legal settlement gain (non-operating): $1 million

Standard Consolidated Total Return Calculation:

First, calculate the base total return from the investment:
Price Appreciation = Ending Value - Beginning Value = $115 million - $100 million = $15 million
Income Distributions = $2 million
Total Gains = $15 million + $2 million = $17 million

Standard Consolidated Total Return = (\frac{$17 \text{ million}}{$100 \text{ million}} = 0.17 \text{ or } 17%)

Adjusted Consolidated Total Return Calculation:

Now, apply the adjustments. Global Innovations decides to adjust for the non-cash integration costs and the unusual legal settlement gain to show what they consider "core" performance.

Adjusted Income Distributions / Gains = Total Gains - One-time Integration Costs + Unusual Legal Settlement Gain
Adjusted Income Distributions / Gains = $17 million - $3 million + $1 million = $15 million

Adjusted Consolidated Total Return = (\frac{$15 \text{ million}}{$100 \text{ million}} = 0.15 \text{ or } 15%)

In this example, the Adjusted Consolidated Total Return of 15% provides Global Innovations' management with a view of performance that excludes specific one-time events, which they believe distorts the recurring earnings per share and long-term value creation.

Practical Applications

Adjusted Consolidated Total Return finds various practical applications across finance and investment:

• Corporate Reporting: Many publicly traded companies present adjusted figures in their financial statements and investor presentations to supplement GAAP results. This is often done to provide what management considers a clearer view of operating trends, especially after significant corporate actions or during periods of unusual events.
• Mergers and Acquisitions (M&A) Analysis: In M&A, analysts often use adjusted returns to assess the true economic benefits of a business combination by stripping out acquisition-related expenses or integration costs that might obscure the ongoing synergy benefits. Accounting for business combinations is governed by detailed rules, such as FASB ASC Topic 805, which guides how assets and liabilities are recognized.³
• Valuation and Performance Comparison: Investors and analysts may use Adjusted Consolidated Total Return for comparative valuation of companies within the same industry, especially if certain non-recurring items disproportionately affect some companies' GAAP results but are not indicative of their underlying business models.
• Internal Management Reporting: Companies use adjusted metrics internally to track progress against strategic goals, evaluate operational efficiency, and make informed capital allocation decisions, often tailoring the adjustments to align with specific internal performance indicators.

Limitations and Criticisms

While Adjusted Consolidated Total Return can offer valuable insights, it is subject to several limitations and criticisms:

• Lack of Standardization: Unlike GAAP or IFRS, there are no universal accounting standards governing how adjusted metrics are calculated. This lack of standardization means that companies can choose what to include or exclude, making direct comparisons between different companies challenging and potentially misleading.
• Potential for Manipulation: Management has discretion over what adjustments are made, which can lead to "earnings management" or present a more favorable picture of financial performance than GAAP results might suggest. Regulators like the SEC frequently comment on companies' use of non-GAAP measures, scrutinizing the appropriateness of adjustments and the prominence given to these figures.²
• Exclusion of "Real" Costs: Critics argue that consistently excluding certain items, even if "non-recurring," can obscure the true costs of doing business. For example, restructuring charges or impairment losses, while sometimes one-off, are real economic events that impact shareholder value.
• Complexity: The need for reconciliation and detailed disclosure adds complexity to financial reporting, potentially making it harder for average investors to understand a company's true financial health.

Investors should always exercise caution and thoroughly review the reconciliation of adjusted metrics to their most directly comparable GAAP figures provided in a company's regulatory filings.

Adjusted Consolidated Total Return vs. Total Return

The key distinction between Adjusted Consolidated Total Return and Total Return lies in the application of specific accounting modifications.

While Total Return provides a universal baseline for investment performance, Adjusted Consolidated Total Return offers a company-specific lens, requiring careful analysis of the adjustments made.

FAQs

What does "adjusted" mean in financial metrics?

"Adjusted" in financial metrics means that the reported number has been modified from its standard GAAP (Generally Accepted Accounting Principles) or IFRS (International Financial Reporting Standards) calculation by adding back or subtracting specific items. These adjustments are typically made by management to provide what they believe is a clearer picture of the company's ongoing operational performance, often by excluding non-recurring, non-cash, or other items deemed not reflective of core business activities.

Why do companies use Adjusted Consolidated Total Return?

Companies use Adjusted Consolidated Total Return, and other adjusted metrics, to highlight their perceived underlying financial performance to investors. This can be particularly relevant after significant events like a large business combination, where one-time integration costs or asset write-downs might obscure the ongoing profitability of the combined entity. It aims to offer a different perspective than strict GAAP results alone.

Is Adjusted Consolidated Total Return a GAAP measure?

No, Adjusted Consolidated Total Return is typically a non-GAAP measure. It deviates from the strict rules and formats of Generally Accepted Accounting Principles (GAAP). Companies providing non-GAAP measures are usually required by regulators, such as the SEC in the United States, to reconcile these adjusted figures back to their most directly comparable GAAP measure and explain the rationale for the adjustments.

How does consolidation affect Adjusted Consolidated Total Return?

Consolidation impacts Adjusted Consolidated Total Return because it means the financial results of a parent company and its subsidiaries are combined as if they were a single economic entity. Therefore, the "total return" component reflects the performance of the entire group. The "adjusted" part then applies modifications to this combined performance, addressing specific items that might be unique to the consolidated group's operations or its formation through a business combination.