Normalized earnings definition
/What are Normalized Earnings?
Normalized earnings are an organization’s reported profits, adjusted to remove the impact of seasonality, as well as unusual revenues and expenses. Adjustments to eliminate the effects of seasonality involve the use of a moving average for revenue and operating expenses; doing so dampens the seasonality effect without entirely eliminating it. Normalization can be useful when there are unusual one-time events that are materially skewing reported results.
Examples of Earnings Normalization Adjustments
Here are several examples of the earnings normalization adjustments that might be applied to an organization’s financial statements:
Lawsuit adjustment. Strip out the one-time gain caused by winning a lawsuit, since it does not reflect the operational capabilities of the organization.
Gain/loss from an asset sale. Strip out large gains or losses from the sale of fixed assets, since these events are not related to operational activities.
Weather-related losses. Strip out losses from adverse weather events, such as the impact of flooding damage on a production facility.
Gain/loss from security sales. Strip out large gains or losses from the sale of securities.
Asset impairment losses. Strip out large losses from recognized asset impairments.
Subsequent events. Strip out the impact of business units that have been sold since the financial statements were produced.
Related AccountingTools Courses
The Interpretation of Financial Statements
How to Use Normalized Earnings
By normalizing earnings, you can gain a better understanding of the performance of a company’s core operations. While the normalization process typically only impacts a company’s income statement, a better approach is to release the entire set of financial statements with these corrections made throughout, so that readers can see the impact on a firm’s financial position and cash flows.
Normalized earnings information is useful for comparisons on a trend line, to see how a company is performing in comparison to its previous normalized results. This information can also be used to compare a firm’s results to the normalized earnings reported by competitors.
Fraudulent Use of Normalized Earnings
The inconsistent application of normalization adjustments to a company’s earnings can be employed to give investors and analysts an excessively rosy view of a company’s results.