What Does Normalized Earnings Mean?
Normalized earnings is the result of adjustments made to the earnings of a company that reflect the up and down cycles of an economy. This includes removing adjustments that are unusual or occur only one time as they do not reflect the usual operations within a company. The normalized earnings amount, after the necessary adjustments, better reflects the true financial position of the company.
Divestopedia Explains Normalized Earnings
Normalized earnings help to determine how much the company can earn during a normal year, especially for cyclical firms. This metric can be particularly important during economic down years when the company's earnings are negative as it assumes that the company will move into the positive earnings zone when the economy returns to an upward curve. In this sense, normalized earnings are most appropriate for cyclical firms that operate in mature business areas.
There are many approaches to calculating the normalized earnings of a firm. One way is to average the dollar earnings of the company over a particular period. This is in fact one of the simplest of all approaches as it averages the earnings without taking into account other external factors. The period over which this average should be computed varies from company to company and, in general, should be the period of the economic cycle. This period can be anywhere between five to 10 years, depending on the business. This approach is best for firms that do not change much in scale or size over this entire period.
The second approach is to average the scaled earnings of the company over a particular period. While this approach is similar to the previous one, it takes into account the scale and size of the firm, so it is likely to be ideal for companies that increase or decrease in size over an economic cycle period.
Using this information, the company's management team can make better decisions that positively impact the company's operations. These earnings have a higher level of impact on middle market companies because they can not only make better decisions, but can also adjust earnings based on their growth and profitability. From an investor's perspective, normalized earnings reflect the net profits and the resultant earnings per share (EPS). For these reasons, normalized earnings is an important part of a company's financial metrics.