Adjusted growth operating income

Adjusted Growth Operating Income is a specialized financial metric used within the broader category of Financial Reporting & Analysis that aims to provide a clearer view of a company's underlying operational profitability by removing certain non-recurring or non-operational items. While traditional operating income is a standard measure derived from a company's financial statements prepared under Generally Accepted Accounting Principles (GAAP), Adjusted Growth Operating Income seeks to offer insights into the core earning power and sustainable growth trajectory of a business by making specific adjustments. It helps investors and analysts assess a company's performance without the distortion of unusual or one-off events. The concept of Adjusted Growth Operating Income is a type of non-GAAP financial measures.

History and Origin

The concept of "adjusted" financial metrics gained prominence as businesses became more complex and engaged in various transactions that could obscure their ongoing operational performance. In the 1990s, companies began providing non-GAAP disclosures, arguing they offered improved insight into a company's core business earnings.²² While companies have historically used non-GAAP measures to highlight changes in operating structure or the impact of mergers and acquisitions, their use expanded significantly in the 1990s as a means to adjust earnings.²¹ This trend led to increased scrutiny from regulators, particularly the U.S. Securities and Exchange Commission (SEC). Following directives from the Sarbanes-Oxley Act of 2002, the SEC adopted Regulation G and amended Item 10 of Regulation S-K in 2003, establishing rules for the use and disclosure of non-GAAP financial measures.²⁰,¹⁹ These regulations require companies to reconcile non-GAAP measures to their most directly comparable GAAP counterparts and prohibit the use of materially misleading non-GAAP financial information.¹⁸,¹⁷

Key Takeaways

• Adjusted Growth Operating Income is a non-GAAP financial metric that aims to present a company's core operating profitability by excluding certain non-recurring or non-operational items.
• The adjustments typically remove expenses or revenues considered outside the normal course of business, such as restructuring charges, impairment losses, or one-time gains.
• This metric is used to provide a clearer view of a company's sustainable operational performance and growth potential.
• While it can offer valuable insights, users should exercise caution as the adjustments are discretionary and can vary significantly between companies, making comparisons challenging.
• Regulatory bodies like the SEC provide guidance on the use and disclosure of non-GAAP financial measures to ensure transparency and prevent misleading presentations.

Formula and Calculation

The specific formula for Adjusted Growth Operating Income can vary from company to company, as it is a non-GAAP measure. However, it generally starts with GAAP operating income and then adds back or subtracts specific items.

A common conceptual formula is:

$\text{Adjusted Growth Operating Income} = \text{Operating Income} \pm \text{Adjustments}$

Where:

• Operating Income: This is derived from a company's income statement, representing revenue minus operating expenses (excluding interest and taxes).
• Adjustments: These are typically non-recurring, non-cash, or non-operational items that management believes distort the true picture of ongoing operations. Common adjustments might include:
  • One-time gains or losses (e.g., from asset sales).
  • Restructuring charges and merger-related costs.
  • Impairment charges.
  • Stock-based compensation expense (sometimes, though increasingly scrutinized by regulators).
  • Non-cash depreciation and amortization of certain acquired intangibles (less common for "growth operating income" specifically, but frequent in other adjusted metrics like EBITDA).

For instance, a company might adjust its operating income to exclude large legal settlements or significant one-off asset write-downs, aiming to present what it considers its ongoing operational performance.

Interpreting the Adjusted Growth Operating Income

Interpreting Adjusted Growth Operating Income involves understanding the rationale behind the adjustments and evaluating whether they genuinely reflect a company's core, sustainable performance. When analyzing this metric, it is crucial to compare it with the reported GAAP operating income and understand the nature of the exclusions. If the adjustments primarily remove truly non-recurring, extraordinary items, Adjusted Growth Operating Income can provide a clearer picture of the operational efficiency and growth trajectory of the business. However, if adjustments consistently exclude recurring cash operating expenses, the adjusted figure might present an overly optimistic view of profitability.¹⁶ Analysts often scrutinize the difference between the adjusted figure and the GAAP figure, as significant or consistently upward adjustments can be a red flag. This metric is most useful when it is consistently applied over time by the same company and accompanied by transparent disclosures of the specific adjustments made.

Hypothetical Example

Consider "Tech Innovations Inc." which reported the following for the fiscal year:

• Revenue: $500,000,000
• Cost of Goods Sold: $200,000,000
• Selling, General, & Administrative Expenses: $150,000,000
• Research & Development Expenses: $50,000,000
• One-time Restructuring Charge: $20,000,000 (related to consolidating facilities)
• Gain on Sale of Non-Core Asset: $10,000,000

First, calculate the GAAP operating income:
Operating Income = Revenue - Cost of Goods Sold - SG&A - R&D - Restructuring Charge
Operating Income = $500,000,000 - $200,000,000 - $150,000,000 - $50,000,000 - $20,000,000 = $80,000,000

Now, let's calculate Adjusted Growth Operating Income. Management decides to exclude the one-time restructuring charge and the gain on sale of a non-core asset, arguing these are not reflective of ongoing operational performance.

Adjusted Growth Operating Income = Operating Income + One-time Restructuring Charge - Gain on Sale of Non-Core Asset
Adjusted Growth Operating Income = $80,000,000 + $20,000,000 - $10,000,000 = $90,000,000

In this hypothetical example, Tech Innovations Inc.'s Adjusted Growth Operating Income of $90,000,000 suggests a higher core operational profitability compared to its GAAP operating income of $80,000,000, after removing items deemed non-recurring.

Practical Applications

Adjusted Growth Operating Income is commonly applied in several real-world financial scenarios. In valuation models, analysts might use adjusted operating income figures to project future cash flows, believing that these adjusted figures better represent the sustainable earning power of a business. This is particularly relevant for companies undergoing significant one-off events, such as large acquisitions or divestitures, where the GAAP earnings before interest and taxes might be skewed. For instance, Signify, a lighting company, reports "Adjusted EBITA," a common non-GAAP measure that adjusts for items like restructuring costs and acquisition-related charges to show core operating performance.¹⁵ Similarly, Aon plc reports "Adjusted operating income" in its earnings releases, highlighting the metric's use for evaluating core performance and growth drivers.¹⁴

Furthermore, in corporate financial planning, management might use Adjusted Growth Operating Income to set internal performance targets or to evaluate the effectiveness of strategic initiatives, as it strips out noise from non-operational events. It can also be used by boards of directors to assess management's performance and determine executive compensation, aiming to align incentives with the company's underlying operational success. However, any such application must be transparent, with clear reconciliations to GAAP measures, to prevent misleading stakeholders. The Financial Accounting Standards Board (FASB) is actively seeking input on standardizing financial key performance indicators (KPIs), including non-GAAP metrics, to improve transparency and comparability for investors.¹³

Limitations and Criticisms

While Adjusted Growth Operating Income can offer valuable insights, it faces several limitations and criticisms. A primary concern is the discretionary nature of the adjustments. Unlike GAAP measures, which adhere to strict accounting standards, companies have significant flexibility in deciding what to exclude or include in their non-GAAP figures, making cross-company comparisons challenging.¹²,¹¹ Critics argue that companies may opportunistically exclude recurring operating expenses, such as stock-based compensation or certain amortization costs, to present a more favorable picture of their financial performance.¹⁰,⁹ This can potentially mislead investors, particularly those who are less sophisticated.⁸

The SEC has consistently scrutinized the use of non-GAAP financial measures, particularly when they appear to mislead investors by excluding normal, recurring cash operating expenses or by being given undue prominence over GAAP results.⁷,⁶,⁵ The case of Groupon's 2011 IPO, where the company used an "Adjusted Consolidated Segment Operating Income" that excluded significant marketing expenses and other core operating costs, exemplifies how such measures can be controversial and lead to regulatory intervention.⁴,³ Moreover, because non-GAAP figures are not subject to the same audit rigor as GAAP financial statements, their reliability can be questioned.² This lack of external audit review for the specific adjustments can reduce confidence in the reported figures.¹

Adjusted Growth Operating Income vs. Operating Income

Adjusted Growth Operating Income and operating income both aim to measure a company's operational profitability, but they differ significantly in their adherence to accounting principles and the scope of what they include.

The main point of confusion often arises because companies present Adjusted Growth Operating Income to provide what they believe is a more insightful view of their business, implying that the GAAP operating income might not fully capture their underlying performance or growth. However, this flexibility can also be a source of potential misrepresentation.

FAQs

What is the primary purpose of Adjusted Growth Operating Income?

The primary purpose of Adjusted Growth Operating Income is to give investors and analysts a clearer view of a company's sustainable core operational profitability and growth. It tries to strip away the impact of unusual or one-time events that might distort the standard GAAP operating income figure.

Why do companies use non-GAAP measures like Adjusted Growth Operating Income?

Companies use non-GAAP financial measures because they believe these metrics provide a better indication of their ongoing business performance and future prospects. Management may feel that certain GAAP expenses, such as large restructuring charges or significant non-cash items, do not reflect the true operational health or growth capacity of the company.

Is Adjusted Growth Operating Income audited?

While the underlying GAAP financial statements are audited, the specific adjustments and the resulting non-GAAP measure like Adjusted Growth Operating Income are generally not subject to the same level of independent external audit scrutiny. Companies are required to reconcile these non-GAAP measures to their most comparable GAAP measure, but the adjustments themselves are management's discretion.

What are common adjustments made to calculate Adjusted Growth Operating Income?

Common adjustments often include adding back or subtracting non-recurring items such as restructuring charges, impairment losses, gains or losses from the sale of assets, legal settlement costs, and sometimes certain non-cash expenses like stock-based compensation, though the latter is heavily scrutinized by regulators. The goal is to focus on recurring items that reflect core business operations and growth.

How does the SEC regulate Adjusted Growth Operating Income?

The SEC regulates non-GAAP financial measures like Adjusted Growth Operating Income through rules such as Regulation G and Item 10(e) of Regulation S-K. These rules require public companies to reconcile non-GAAP figures to their GAAP equivalents, provide a clear explanation of why management believes the non-GAAP measure is useful, and ensure that the non-GAAP measure is not given undue prominence or used in a misleading way, especially if it excludes normal, recurring cash capital expenditures.