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The flattery industry

That flattery works wonders is hardly a new thought. Dig into Chaucer’s Canterbury Tales and you will find the Wife of Bath, a sort of 14th century femme fatale, recommending flattery as perhaps the most successful means of seduction. Small wonder then that, 600 years later and much more prosaically, company bosses use flattery as the bait to hook shareholders. Except that the object of their flattery is a bit different. Rather than whisper sweet nothings to would-be investors, bosses talk up the performance of the companies they run. Everything becomes bigger and better, slimmer and sturdier, leaner and meaner.

The trouble is that flattery is subject to the law of diminishing returns – the more that bosses flatter their company’s performance, the more the pressure grows to maintain the illusion. So flattery proliferates. Simultaneously, expanding in the opposite direction is the regulatory drive for a bit less smoke and mirrors, a bit more objectivity, rigour and clarity.

Thus this week the Financial Reporting Council (FRC), the accountancy industry’s regulator, returned to one of its favoured subjects, quoted companies’ use of subjective and inconsistent ways to quantify – and almost invariably flatter – their performance. It dumps these under the heading ‘alternative performance measures’, cannot resist turning that into an acronym – APMs – and points out that almost all companies use them. The council’s especial complaints are that:

●  Almost always, the effect of APMs is to boost company profits rather than depress them, and one in three companies in the sample the council researched managed to turn losses into profits using underlying measures.

●  Too often companies use the generic term ‘underlying’ when quantifying alternative profits, costs or whatever, but too rarely do they explain how ‘underlying’ is defined.

●  Sometimes companies give more prominence in their accounts to these optional underlying figures than to the statutory equivalents.

Granted, the FRC’s latest effort on alternative measures is not exactly exhaustive. It is based on the detailed examination of recent accounts of only 20 UK-quoted companies. Of these, five are FTSE 100 blue-chips, seven from the FTSE 250 index and just one from Aim. Even so, the report offers investors useful insights into the best and the worst that quoted companies serve up and provides an accounting discussion along the way. As such, it is well worth downloading from the council’s website (

One thing is abundantly clear – companies are addicted to their APMs. All 20 in the sample use alternative ways to present net debt and 19 showed adjusted ‘Ebitda’, the popular cash profits measure that, as Micro Focus International (MCRO) helpfully explains in its 2020 accounts, “eliminates potential differences in performance caused by variations in capital structures, tax positions, the cost and age of tangible assets and the extent to which intangibles are identifiable” – the reporting council liked that note very much. Likewise, profits – both at operating level and pre-tax – were almost certain to be shown in adjusted form.

In addition, three-quarters of companies reviewed offered alternative ways to show earnings per share (EPS). Even free cash flow – a popular item among investors because it aims to show the cash left over each year for shareholders, but not an obligatory one – got more than one measure in two-thirds of the reports reviewed.

As for the specific items that company bosses are most likely to adjust for (ie, eliminate) on the accounting trip from statutory to underlying, none is more fingered than restructuring charges, those annoying costs that so many bosses like to suggest are occasional when, actually, they are habitual. Yet it is important that such charges really are occasional, says the FRC, otherwise there is no justification for stripping them out of the underlying measure and hence no justification in the notion that the underlying figures somehow offer a truer picture of a company’s performance. But too often, the council adds, company accounts don’t explain why the bosses have decided some items should be classified as ‘restructurings’ in the first place, how long the restructuring programme will run and what fraction of the total charges will be cash costs.

Similar comments might be made about the other items that companies habitually adjust for – the profit or loss on disposals of long-term assets, impairment charges for assets that haven’t made the grade and amortising (ie, writing down) the balance-sheet value of acquired intangible assets (ie, the excess over book value that was originally paid for businesses).

For more on this topic

The Hut Group - Adjusted earnings: fact or fiction?

FRC wants an end to wacky adjusted numbers

To get a fix on the extent of companies’ addiction to adjustments and alternative measures, it is worth turning attention to one of the great users, GlaxoSmithKline (GSK). Table 1 shows its broad-brush effects on the pharmaceuticals group’s profits and EPS for the five years 2016 to 2020 – and they are substantial. In every year adjusted operating profit is higher than the basic number and the same is true when results are distilled down to EPS. True, as the bottom two rows show, in the latest year there is only a minor difference between basic and adjusted EPS. Even so, on average over the five years Glaxo’s adjusted EPS were two-and-a-half times its basic EPS.


Table 1: The broad-brush changes
year to end December (£m)20202019201820172016
Basic operating profit7,7836,9615,4834,0872,598
Adjusted operating profit8,9068,9728,7458,5687,871
Adj'd profit/Basic profit (%)114129159210303
Basic earnings per share (p)115.593.973.731.418.8
Adjusted earnings per share (p)115.9123.9119.4111.8100.6
Adj'd eps/basic eps (%)100132162356535
Source: GlaxoSmithKline annual report 2020


Table 2 shows the detail of how basic operating profit became the adjusted item. There is the consistent and substantial positive of adding back charges for amortisation, impairments and – especially – restructurings. Yet the biggest items are probably those least clearly explained by Glaxo. In 2020, for instance, there was a £2.8bn charge for disposals, although Glaxo gives them the more formal term, ‘divestments and other items’. Most of this probably relates to writing back the profit over book value on Glaxo’s sale of Horlicks and other consumer brands. Meanwhile, accounting alignments for major transactions provides a steady and substantial source of profitable adjustments, including £4bn-plus in 2016. Quite how and where these arise, Glaxo does not say.


Table 2:  The detail
year to end December (£m)20202019201820172016
Basic operating profit7,7836,9615,4834,0872,598
Amortisation of intangibles775777580591588
Impairment of intangibles2638311668820
Transaction accounting & other1,3763451,9772,2654,119
Adjusted operating profit8,9068,9728,7458,5687,871
Source: GlaxoSmithKline annual report 2020


Not that it can necessarily be criticised for that. There is a limit to how much information can be provided in any annual report, even the 300-page door-stopper that Glaxo produces each year. Besides, the report makes clear Glaxo’s bosses think adjusted results help improve understanding of the group’s performance but, tellingly, they add that such figures should not be considered “a substitute for, or superior to, information presented in accordance with IFRS (accounting standards)”. They also warn that Glaxo’s adjusted results “may not be directly comparable with similarly described measures used by other companies”. The FRC approves of notes such as those very much.

The scale of the addiction to underlying results can be grasped by a database scan of component companies of the FTSE All-Share index. Working within the limitations of our database, we assumed that profit before extraordinary items was a decent proxy for adjusted operating profit and that profit after extraordinaries could substitute for basic operating profit. The aggregate effect for 380 All-Share companies that provided sufficient data was that, for the most recent financial year, profit before extraordinaries was 40 per cent more than basic operating profit and for the year before it was 50 per cent more.

First, investors must be aware of this – forewarned is forearmed. Second, in their research of individual companies they must employ the rule of thumb that the wider and the more consistent the gap in favour of adjusted profit at the expense of basic profit, the more sceptical they should be. Conversely, in an ideal world they are looking for companies where adjustments are few and far between, where restructurings – especially – are absent and where there are few, if any, items that prompt the response, ‘what on Earth does that mean?’ It is much the same for companies as it is in all walks of life – the best don’t need to be flattered.


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