Adjusted incremental growth rate

What Is Adjusted Incremental Growth Rate?

The Adjusted Incremental Growth Rate (AIGR) is a financial metric used to assess the growth in a company's financial performance after accounting for specific non-recurring or unusual items. It falls under the broader category of financial analysis. Unlike raw growth rates, AIGR aims to provide a clearer picture of sustainable, underlying business expansion by normalizing for elements that may distort reported figures. This adjusted approach is particularly valuable when evaluating earnings, revenue, or other key financial indicators, as it helps stakeholders understand the true operational trajectory of a business. The Adjusted Incremental Growth Rate considers how core operations are expanding, free from the noise of one-time events or accounting adjustments.

History and Origin

The concept of adjusting financial figures to reflect a company's ongoing operational performance gained prominence as businesses became more complex and engaged in a wider variety of transactions, some of which were not reflective of core operations. The practice of using "adjusted earnings" has been prevalent for at least 25 years among public companies, and increasingly so in debt markets¹⁷. This trend intensified following major accounting scandals and the subsequent push for greater transparency. Regulatory bodies, notably the U.S. Securities and Exchange Commission (SEC), introduced guidelines to govern the use of non-GAAP (Generally Accepted Accounting Principles) financial measures. For instance, Regulation G, adopted in 2003 under the Sarbanes-Oxley Act, requires companies to reconcile non-GAAP measures to their most directly comparable GAAP financial measure, ensuring that adjusted figures are not misleading and providing investors with balanced financial disclosure¹⁴, ¹⁵, ¹⁶. This regulatory environment has shaped how companies present adjusted figures, including those used to calculate an Adjusted Incremental Growth Rate, emphasizing the need for clarity and comparability.

Key Takeaways

• Underlying Performance: The Adjusted Incremental Growth Rate isolates and highlights growth attributed to a company's core operations.
• Normalization: It filters out the impact of one-time gains, losses, or other non-recurring items that can skew traditional growth calculations.
• Enhanced Comparability: AIGR can improve the comparability of financial performance between different periods or across different companies by removing unique distortions.
• Informed Decision-Making: Investors and analysts can use AIGR to make more informed decisions by focusing on the sustainable growth drivers of a business.
• Transparency Requirements: Companies presenting adjusted metrics are typically required to provide clear reconciliations to GAAP measures.

Formula and Calculation

The Adjusted Incremental Growth Rate is not a universally standardized formula like some GAAP measures. Instead, it is a conceptual approach to growth calculation that requires identifying and excluding specific non-recurring or non-operational items from the financial data before calculating the growth rate.

To calculate the Adjusted Incremental Growth Rate, the general steps involve:

1. Identify the baseline financial metric: This could be revenue, net income, operating income, or another relevant figure.
2. Identify and quantify non-recurring or unusual items: These are expenses or revenues that are not expected to recur in the normal course of business operations. Examples include one-time legal settlements, gains or losses from asset sales, significant restructuring charges, or large impairment write-downs.
3. Adjust the current and prior period metrics: Add back expenses and subtract gains that are deemed non-recurring to arrive at "adjusted" figures for both periods.
4. Calculate the growth rate using the adjusted figures.

The formula can be expressed as:

Where:

• Adjusted Current Period Metric = (Reported Current Period Metric) $\pm$ (Adjustments for Current Period)
• Adjusted Prior Period Metric = (Reported Prior Period Metric) $\pm$ (Adjustments for Prior Period)

For example, if a company reports net income, the adjustment process would involve determining what portion of that net income is from its core business operations and excluding any items that are considered extraordinary or non-recurring. This allows for a more "normalized" view of profitability growth.

Interpreting the Adjusted Incremental Growth Rate

Interpreting the Adjusted Incremental Growth Rate involves looking beyond the raw percentage and understanding the context of the adjustments made. A positive AIGR indicates that the company's core operations are expanding, while a negative AIGR suggests a contraction in the underlying business. The magnitude of the rate reveals the speed of this expansion or contraction.

When evaluating the AIGR, it is crucial to consider:

• Nature of Adjustments: Are the adjustments truly non-recurring and unrelated to core operations? Or are they frequently recurring items that management is trying to exclude to present a more favorable picture? The SEC has provided guidance on what constitutes misleading non-GAAP measures, including performance measures that exclude normal, recurring, cash operating expenses¹³.
• Consistency: How consistently has the company applied its adjustments over different reporting periods? Inconsistent adjustments can hinder trend analysis.
• Industry Norms: Compare the AIGR to industry benchmarks and peer companies. Some industries may have specific recurring non-GAAP adjustments that are widely accepted.
• Qualitative Factors: The AIGR should not be viewed in isolation. It should be considered alongside other financial statements, management discussions, and broader economic conditions to gain a holistic understanding of the company's performance.

Hypothetical Example

Consider a hypothetical manufacturing company, "Widgets Inc.," that reported the following net income figures:

• Year 1 Net Income: $10,000,000
• Year 2 Net Income: $12,000,000

In Year 2, Widgets Inc. also recognized a one-time gain of $1,500,000 from the sale of an unused property. This gain is not expected to recur and is unrelated to their core widget manufacturing business.

To calculate the Adjusted Incremental Growth Rate for net income:

1. Adjust Year 2 Net Income:

   • Reported Year 2 Net Income: $12,000,000
   • Less: One-time gain from property sale: $1,500,000
   • Adjusted Year 2 Net Income: $10,500,000

2. Adjust Year 1 Net Income: Assume no non-recurring items in Year 1, so Adjusted Year 1 Net Income remains $10,000,000.

3. Calculate Adjusted Incremental Growth Rate:

   $$\text{AIGR} = \left( \frac{\$10,500,000 - \$10,000,000}{\$10,000,000} \right) \times 100\%$$ $$\text{AIGR} = \left( \frac{\$500,000}{\$10,000,000} \right) \times 100\%$$ $$\text{AIGR} = 0.05 \times 100\%$$ $$\text{AIGR} = 5\%$$

In this example, while the reported net income growth rate would be (\left( \frac{$12,000,000 - $10,000,000}{$10,000,000} \right) \times 100% = 20%), the Adjusted Incremental Growth Rate reveals a more modest 5% growth in the company's core operations. This distinction is crucial for understanding the underlying health and sustainable growth of Widgets Inc.'s primary business. It helps analysts evaluate the company's operating performance without the distortion of a singular event.

Practical Applications

The Adjusted Incremental Growth Rate finds practical applications across various financial disciplines, offering a more refined view of performance:

• Equity Research and Valuation: Equity analysts frequently use AIGR to assess the true earning power of a company, distinguishing between one-off events and sustainable growth trends. This is particularly important for discounted cash flow models, where future cash flows are projected based on core business growth¹².
• Credit Analysis: Lenders and credit rating agencies analyze AIGR to evaluate a company's ability to generate consistent cash flows from its operations to service its debt obligations. Companies with large adjusted-earnings differentials may have weaker underlying operational performance¹¹.
• Mergers and Acquisitions (M&A): During due diligence, acquiring companies use AIGR to understand the target company's core profitability and growth potential, independent of any unusual historical events. This helps in fair valuation and integration planning.
• Financial Reporting and Investor Relations: While regulated by bodies like the SEC, companies often present adjusted financial metrics in their earnings calls and investor presentations to highlight their operational performance and guide investor expectations¹⁰. For example, companies like GE Vernova and Honeywell often report adjusted profit figures alongside their GAAP results to provide a clearer picture of their operational performance⁸, ⁹. PUMA also recently announced preliminary results for the second quarter of 2025, including adjusted EBIT figures⁷.
• Strategic Planning and Performance Management: Internally, companies use AIGR to track the effectiveness of strategic initiatives and operational improvements, allowing management to focus on areas that drive sustainable long-term growth.
• Economic Analysis: At a macroeconomic level, adjusted growth rates of specific sectors or industries can provide clearer insights into underlying economic trends, removing the impact of volatile or one-off sector-specific events, which can be useful for broader economic forecasting.

Limitations and Criticisms

While the Adjusted Incremental Growth Rate offers valuable insights, it is not without limitations and criticisms:

• Subjectivity of Adjustments: The primary criticism revolves around the subjective nature of what constitutes a "non-recurring" or "unusual" item. Management has discretion in deciding what to exclude, which can lead to figures that may not truly reflect the company's financial reality⁶. Some adjustments may ignore real expenses, such as stock-based compensation, which Warren Buffett has highlighted as a significant issue⁵.
• Potential for Misleading Reporting: If not applied transparently and consistently, AIGR can be used to present a more favorable picture of performance than is warranted, potentially misleading investors. The SEC has actively provided updated guidance to address potentially misleading uses of non-GAAP financial measures, emphasizing that such measures should not be given undue prominence³, ⁴.
• Lack of Standardization: Unlike GAAP, there is no universal standard for calculating adjusted metrics across companies or industries. This lack of standardization can make it challenging for investors to compare the AIGR of different companies.
• Ignoring Real Costs: Critics argue that consistently excluding certain "one-time" costs, such as restructuring charges or litigation expenses, can mask recurring operational inefficiencies or risks inherent to the business model. These costs, even if irregular, are still real expenses incurred by the company.
• Focus on Short-Term Gains: An over-reliance on adjusted growth rates might encourage management to focus on short-term adjustments rather than addressing fundamental issues that impact long-term financial health.

Despite these criticisms, when used prudently and transparently, the Adjusted Incremental Growth Rate remains a useful tool for gaining a deeper understanding of a company's core operational growth.

Adjusted Incremental Growth Rate vs. Organic Growth Rate

The Adjusted Incremental Growth Rate (AIGR) and Organic Growth Rate are both measures that aim to provide a clearer picture of a company's underlying performance by excluding certain distorting factors. However, they differ in their primary focus and the types of items they adjust for.

While AIGR cleanses a financial metric of one-off anomalies, the Organic Growth Rate specifically isolates growth attributable to a company's existing business lines, without the influence of external corporate actions like mergers or acquisitions. Both are valuable tools for investor relations and financial analysis, but they serve distinct purposes in painting a comprehensive picture of a company's growth trajectory.

FAQs

Why is an Adjusted Incremental Growth Rate important?

The Adjusted Incremental Growth Rate is important because it helps financial professionals and investors understand the true, underlying performance of a business by removing the impact of one-time or unusual events that can distort reported financial figures. This provides a more accurate view of a company's sustainable growth drivers.

What types of items are typically adjusted for in AIGR?

Items typically adjusted for include non-recurring gains or losses from asset sales, significant restructuring charges, legal settlements, impairment write-downs, and other extraordinary expenses or income that are not part of a company's ongoing core operations. These adjustments aim to present a picture of "core earnings".

Is Adjusted Incremental Growth Rate a GAAP measure?

No, the Adjusted Incremental Growth Rate is not a Generally Accepted Accounting Principles (GAAP) measure. It is a non-GAAP financial metric. Companies that disclose non-GAAP measures are required by the SEC to reconcile them to the most directly comparable GAAP financial measure to ensure transparency¹, ².

Can AIGR be used for forecasting?

Yes, AIGR can be particularly useful for financial forecasting. By focusing on core operational growth, it provides a more stable and predictable basis for projecting future performance than raw, unadjusted growth rates, which might be influenced by volatile, non-recurring events.

What are the risks of relying solely on AIGR?

Relying solely on AIGR can be risky because the adjustments are often subjective and at the discretion of management. This could potentially lead to an overly optimistic view of a company's performance if recurring operational costs are consistently excluded. It is crucial to review the reconciliation to GAAP figures and consider all financial information. It's important to understand the full context of a company's cash flow.