Adjusted growth profit

What Is Adjusted Growth Profit?

Adjusted Growth Profit is a non-Generally Accepted Accounting Principles (GAAP) financial metric that aims to provide a clearer view of a company's core operating profitability by excluding certain expenses that may be considered non-recurring, non-cash, or otherwise distortive to ongoing operations. This metric falls under the broader category of financial reporting and performance measurement, offering stakeholders an alternative perspective beyond traditional GAAP measures. While standard Gross Profit only subtracts the Cost of Goods Sold (COGS) from revenue, Adjusted Growth Profit takes this a step further by removing other specific, often non-direct, costs that management deems non-indicative of the company's sustained profit-generating ability. The objective of presenting Adjusted Growth Profit is to highlight the underlying operational efficiency and growth trajectory of a business, particularly for investors and internal management seeking to assess sustainable performance.

History and Origin

The concept of "adjusted" financial metrics, including Adjusted Growth Profit, emerged from companies' desire to present their financial performance in a way they believe better reflects their true operational results, often by excluding items that distort comparison or are not considered part of core business activities. This practice became more prominent with the rise of technology companies and highly acquisitive businesses, which often incurred significant non-cash expenses like stock-based compensation or large, infrequent restructuring charges. These "non-GAAP financial measures" began to be widely used in earnings releases and investor communications to supplement the traditional financial statements.

However, the proliferation and varied application of these adjusted metrics led to concerns among regulators and investors regarding comparability and potential for manipulation. The U.S. Securities and Exchange Commission (SEC) has historically provided guidance and interpretations to regulate the use of non-GAAP financial measures, seeking to ensure they are not misleading and are accompanied by adequate reconciliation to GAAP figures. The SEC's efforts, including updated guidance in December 2022, underscore the ongoing scrutiny of these self-defined metrics to protect investors.²⁰,¹⁹ In 2011, for instance, Groupon Inc. faced SEC scrutiny over its "adjusted consolidated segment operating income," which notably excluded marketing expenses and stock-based compensation, drawing attention to the subjective nature of such adjustments.¹⁸ Similarly, the CFA Institute, a global association of investment professionals, has highlighted investor concerns about the communication, consistency, comparability, and transparency of non-GAAP financial measures.¹⁷

Key Takeaways

• Adjusted Growth Profit is a non-GAAP financial metric used to present a company's operational profitability by excluding specific, often non-recurring or non-cash, expenses.
• It provides management and investors with a customized view of a company's core performance, aiming to remove "noise" from the standard Gross Profit calculation.
• The calculation involves starting with Gross Profit and making specific additions or subtractions as determined by management to reflect underlying business economics.
• While potentially offering useful insights into a company's sustainable earning power, Adjusted Growth Profit lacks standardization, making comparisons across companies challenging.
• Regulators, such as the SEC, monitor the use of adjusted metrics to ensure they are not misleading and are reconciled clearly with GAAP equivalents.

Formula and Calculation

The calculation of Adjusted Growth Profit typically starts with the standard Gross Profit figure and then applies specific adjustments. While there isn't one universal "Adjusted Growth Profit" formula, the underlying principle involves identifying and backing out expenses that management believes are not indicative of the core, ongoing operations' profitability.

A common representation of the concept is:

Where:

• Revenue: The total sales generated by the company from its primary business activities over a period.
• COGS (Cost of Goods Sold): The direct costs attributable to the production of the goods or services sold by a company, including direct materials and direct labor. This is a key component in calculating traditional gross profit.
• Specific Adjustments: These are the particular expenses that management chooses to add back or subtract from the typical gross profit calculation to arrive at the "adjusted" figure. These could include items like:
  • Non-recurring restructuring costs
  • One-time legal settlements
  • Significant non-cash expenses (e.g., certain types of depreciation or amortization that are deemed extraordinary)
  • Inventory carrying costs (for a more precise adjusted gross margin in some contexts)

For example, if a construction business has revenue of $35,000,000, material costs of $12,000,000, labor costs of $14,000,000, and equipment rental specific to jobs of $1,000,000, its Adjusted Gross Profit would be $8,000,000. This calculation excludes administrative equipment rental, as it's not directly tied to revenue generation.¹⁶

Interpreting the Adjusted Growth Profit

Interpreting Adjusted Growth Profit involves understanding management's perspective on what constitutes "core" operational profitability. Companies use Adjusted Growth Profit to highlight a specific facet of their performance, often presenting it as a more representative measure of the ongoing business without the influence of unusual or non-cash items. For instance, a rapidly growing technology company might exclude significant upfront research and development costs or large, one-time acquisition-related expenses to show investors its profitability once these initial hurdles are cleared.

Analysts and investors often use Adjusted Growth Profit to evaluate a company's ability to generate cash flow from its primary operations, assess the efficiency of its production and sales, and forecast future performance.¹⁵ By removing fluctuations caused by non-recurring events, Adjusted Growth Profit can help identify underlying trends in a company's financial health, which might otherwise be obscured in GAAP (Generally Accepted Accounting Principles) financial statements. When analyzing this metric, it is crucial to examine the specific adjustments made and understand the rationale behind them. What one company considers an "adjustment," another might consider a regular operating expense. Comparing Adjusted Growth Profit over different periods for the same company can reveal changes in operational efficiency and growth rates.¹⁴ However, comparing it across different companies or industries can be challenging due to the lack of standardization in its calculation.

Hypothetical Example

Consider "AlphaTech Inc.," a software company that generated $100 million in annual revenue.

Their standard financial figures show:

• Revenue: $100,000,000
• Cost of Goods Sold (COGS): $20,000,000 (direct costs of software development and hosting)

This results in a traditional Gross Profit of:

Now, let's assume AlphaTech Inc. incurred the following additional expenses during the year that management wishes to adjust for to show its "Adjusted Growth Profit":

• One-time patent litigation settlement: $5,000,000
• Stock-based compensation for new executive hires (non-cash): $3,000,000

To calculate the Adjusted Growth Profit, AlphaTech Inc. would typically start with its revenue and subtract COGS, then make adjustments for the items it deems non-core or non-recurring:

In this hypothetical example, AlphaTech Inc. reports an Adjusted Growth Profit of $72,000,000. This figure is lower than its standard Gross Profit because the company has chosen to include certain expenses (like the patent settlement and stock-based compensation) as direct deductions from revenue when calculating this specific "adjusted" metric, aiming to present a more granular view of profit after what they consider directly related costs and significant unusual items. This provides a different lens for internal financial analysis and for external investor relations efforts.

Practical Applications

Adjusted Growth Profit is a flexible metric that finds various applications in financial analysis and corporate strategy, particularly within the realm of performance measurement.

• Internal Performance Evaluation: Companies often use Adjusted Growth Profit internally to assess the efficiency of their core production and sales processes, separate from the impact of one-time events or non-cash charges. This helps management identify areas for cost control or pricing adjustments without the distortion of unusual items. It can also be a key metric in setting performance bonuses and evaluating departmental effectiveness.¹³
• Forecasting and Budgeting: By focusing on a more normalized measure of profit, businesses can develop more accurate forecasts for future revenue and profitability. This stability aids in better resource allocation and capital expenditure planning.¹²
• Mergers and Acquisitions (M&A): In M&A due diligence, buyers frequently look at adjusted financial metrics, including variations of adjusted gross profit, to understand the target company's sustainable earning power. Adjustments are often made to normalize earnings by removing expenses unique to the seller or non-recurring items, allowing for a clearer valuation of the underlying business.¹¹
• Startups and High-Growth Companies: For young companies that may not yet be profitable under traditional Generally Accepted Accounting Principles (GAAP) due to significant upfront investments or stock-based compensation, Adjusted Growth Profit can offer a narrative of their operational progress and growth potential to investors.
• Industry-Specific Analysis: In some industries, certain costs are consistently adjusted out by participants to provide industry-specific performance indicators. For example, some sectors might commonly adjust for specific supply chain disruptions or regulatory compliance costs to present a more comparable Adjusted Growth Profit across peers.

While offering these benefits, it is critical that any presentation of Adjusted Growth Profit is transparent and reconciles back to GAAP measures, as mandated by regulatory bodies like the SEC.¹⁰

Limitations and Criticisms

While Adjusted Growth Profit can offer a tailored view of a company's financial performance, it is subject to several significant limitations and criticisms, primarily because it is a non-GAAP financial measure.

One major criticism is the lack of standardization. Unlike measures defined by Generally Accepted Accounting Principles (GAAP), there are no universal rules governing how Adjusted Growth Profit is calculated. This means that companies have considerable discretion in deciding which expenses to exclude or include, leading to inconsistencies.⁹ Consequently, comparing Adjusted Growth Profit across different companies, or even across different reporting periods for the same company, can be misleading.⁸,⁷

Another concern is the potential for opportunistic reporting or "earnings management." Companies might use the flexibility of Adjusted Growth Profit to present a more favorable financial picture, potentially excluding recurring operating expenses by labeling them as "non-recurring" or "one-time" to inflate reported profitability.⁶,⁵ This practice can obscure a company's true financial health and may mislead investors. For instance, companies like WeWork have faced backlash for using highly adjusted metrics that excluded significant operational expenses, contributing to a distorted view of their financial health.⁴

Furthermore, since Adjusted Growth Profit is not a GAAP measure, it is generally not subject to the same level of independent audit scrutiny as GAAP figures within the primary financial statements. While auditors review information in documents containing official financial statements, non-GAAP measures are often presented in supplemental materials or press releases, where the auditor's role may be more limited.³ This lack of direct audit can reduce the reliability and verifiability of the reported Adjusted Growth Profit.

Regulators, including the SEC, have expressed ongoing concerns about potentially misleading non-GAAP financial measures. They frequently issue comments and guidance to ensure companies provide clear reconciliations to the most comparable GAAP measures and do not give undue prominence to non-GAAP metrics.² Investors should exercise caution and critically examine the adjustments made to arrive at Adjusted Growth Profit, always cross-referencing with the GAAP figures to gain a complete understanding of a company's financial standing. The CFA Institute has also published research highlighting investor concerns regarding the transparency and comparability of these alternative performance measures.¹

Adjusted Growth Profit vs. Gross Profit

Adjusted Growth Profit and Gross Profit are both measures of a company's profitability, but they differ significantly in their scope and the expenses they consider.

Gross Profit is a standardized metric calculated directly from a company's income statement. It represents the revenue remaining after subtracting only the direct costs associated with producing the goods or services sold, known as the Cost of Goods Sold (COGS). This metric provides a fundamental view of a company's production efficiency and pricing strategy. It does not account for any operating expenses, administrative costs, or other non-direct costs of doing business.

Adjusted Growth Profit, on the other hand, is a non-GAAP financial measure. It starts with a base profit figure (often similar to or derived from Gross Profit) and then applies further adjustments chosen by management. These adjustments typically involve adding back or subtracting expenses that are deemed non-recurring, non-cash, or otherwise outside of the company's core, ongoing operations. For example, a company might adjust Gross Profit for one-time legal settlements, significant restructuring charges, or specific types of non-cash compensation to arrive at an Adjusted Growth Profit figure. The primary purpose of Adjusted Growth Profit is to provide a "cleaner" view of core operational performance by filtering out what management perceives as "noise."

The key distinction lies in standardization and discretion. Gross Profit adheres to strict Generally Accepted Accounting Principles (GAAP) and is consistently calculated across all companies. Adjusted Growth Profit, however, is a customized metric with no standardized definition, meaning its calculation can vary significantly from one company to another, or even year to year within the same company. This lack of standardization makes direct comparisons between companies challenging and requires careful scrutiny of the specific adjustments made.

FAQs

What types of adjustments are typically made in Adjusted Growth Profit?

Adjustments to calculate Adjusted Growth Profit often include removing non-recurring expenses (such as large legal settlements or restructuring costs), significant non-cash charges (like certain types of stock-based compensation or large impairment charges), or other specific items that management believes do not reflect the company's ongoing operational performance. The aim is to present a clearer picture of core profitability.

Why do companies report Adjusted Growth Profit if it's not a standard GAAP measure?

Companies report Adjusted Growth Profit and other non-GAAP financial measures to offer what they believe is a more relevant view of their underlying business performance, free from distortions caused by unusual events or non-cash accounting entries. They aim to provide insights into how management views the company's core operations and its sustainable earning power, particularly for investor relations and analytical purposes.

Is Adjusted Growth Profit audited?

While the underlying components of Adjusted Growth Profit (like revenue and Cost of Goods Sold (COGS)) come from audited financial statements prepared under GAAP, the "adjusted" figure itself is not directly audited in the same way. Regulators require that non-GAAP measures be reconciled to their most directly comparable GAAP measure, and auditors review the financial reports as a whole. However, the specific subjective adjustments made to arrive at an adjusted metric typically fall outside the scope of a direct audit opinion on that particular adjusted number.

How does Adjusted Growth Profit relate to a company's valuation?

Adjusted Growth Profit can be used by analysts and investors as an input for valuation models, particularly when trying to assess a company's ongoing earning potential. By focusing on core profitability, it can help in forecasting future earnings and applying valuation multiples. However, its non-standardized nature means that users must understand and agree with the adjustments made to ensure a meaningful valuation.

What should investors look for when analyzing Adjusted Growth Profit?

Investors should always look for a clear reconciliation of Adjusted Growth Profit to its most comparable GAAP measure (typically Gross Profit or Operating Income). They should scrutinize the specific adjustments made, understand the company's rationale for each, and assess whether those adjustments are truly non-recurring or non-operational. It is also important to compare the Adjusted Growth Profit with the GAAP figures to understand the magnitude of the adjustments and potential impact on the overall financial picture.