Normalised earnings examples
Normalised earnings show the company’s financial results without the effects of non-recurring charges or gains, which could result from unusual one-time events or seasonality.
The one-time or non-recurring items affect a company’s short-term cash flow, but does not entirely depict its long-term financial performance. Adjustments to the financial statement are made by removing a one-off or non-recurring revenue or expense from the earnings before interest, tax, depreciation and amortisation (EBITDA) or earnings before interest and tax (EBIT).
Removing the one-off items results in figures that reflect or represent the actual future earnings of a company’s core business. Normalised earnings are considered the most accurate way to assess a company’s financial health.
As an example, say a retail company sells its old store building. The accountant must remove the revenue from the sale of the building from the company’s income statement in order to normalise the earnings.
According to Divestopedia and Concept Financial Service Group, items that are adjusted or removed in the process of normalised earnings include the following:
How to calculate normalised earnings?
There is no special normalised earnings formula, but earnings for companies with seasonality or sales cycles can be adjusted by calculating a moving average over several periods. The arithmetic average of a set of data/numbers over a specific number of days in the past is the simplest form of calculating the moving average.
For example, if a company earns $1,000 in April, $1,500 in May and $2,000 in June and uses a two-month moving average, its normalised earnings would be $1,250 for May and $1,750 for June.
Calculating moving averages can mitigate the impacts of short-term, random events on the company’s earnings over a specific timeframe.
Why are normalised earnings important?
Normalised earnings can give a more accurate comparison between companies. One-time or non-recurring expense/revenue unrelated to a company’s core business can distort specific financial metrics, such as earnings per share (EPS).
By using normalised earnings per share, investors can better assess and compare companies based on the quality of their core activities rather than being affected by the transient lift or impact of a one-time incident.
In the event of a potential acquisition or purchase, one-time expenses such as wages or owners’ salary, or revenue from a sale of depreciating assets, are eliminated from the financial statements. Once these are removed from the earnings, the figures will depict more accurately what kind of potential profits the company’s buyer could expect.
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