Normalized Financial Statements - Explained
What are Normalized Financial Statements?
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Table of ContentsWhat are Normalized Financial Statements?How are Normalized Financial Statements Used?Adjusting for the owners salary and expensesAdjusting for the Rental Expenses and EarningsRemoving Non-recurring Expenses and EarningsEliminating Expenses of Extraordinary EventsRemoving Discretionary ExpensesAcademic Research on Normalized Financial Statements
What are Normalized Financial Statements?
The non-recurring expenses and revenues of a company are adjusted to get a real picture of the company's financial performance. This adjusted financial statement is known as the normalized financial statement. The financial statement of a company often includes expenses and revenues that are not part of its regular business operations, those non-operating assets or liabilities and all other anomalies are removed from the statement by normalizing it. A normalized financial statement allows a reliable and even comparison.
How are Normalized Financial Statements Used?
Normalization of financial statement is often done during fundraising from external sources. The investors may want a normalized financial statement to get the actual picture of the company's finance including usual cash flow, revenue, and expenses. Similarly, a potential buyer wants a normalized financial statement to estimate the profitability of the business. All the discretionary expenses, one-time earning or loss are removed from the financial statement for normalizing it. A normalized statement reflects on the usual transaction of a company. Following are some of the examples of how to normalize a financial statement.
Adjusting for the owners salary and expenses
In private companies, generally, the owners decide their own salary and allowances. They withdraw that amount from the company's account. The allowances may include travel allowance, internet, and phone bill, fuel and vehicle cost, entertainment cost etc. The net revenue of the company gets reduced by these expenditures. While normalizing the financial statement all these expenses must be added back to the company's earning.
Adjusting for the Rental Expenses and Earnings
If a company is operated from the rental property, the rental expense needs to be adjusted according to the market price. Often the companies pay a rent that is higher or lower than the market value. The expense is adjusted for removing this discrepancy. Also, if a company earns any money from its rented-out properties that are not a part of its core business operation, the whole amount needs to be eliminated from the financial statement. Any loans related to such properties are also to be eliminated from the statement.
Removing Non-recurring Expenses and Earnings
A company may earn a revenue from selling a land or an asset in a year. All such non-recurring earnings should be removed from the normalized statement. Similarly, any one-time expense like renovation, loss from disposing of an asset, insurance payout etc. is to be added back to the company's revenue to get an actual picture of the company's financial performance.
Eliminating Expenses of Extraordinary Events
A company may have to pay for extraordinary events such as material storm damage, lawsuits, regulatory ruling etc. These expenses need to be added back to the company's revenue while normalizing a financial statement.
Removing Discretionary Expenses
The owner of a company may pay an untimely bonus or may organize a trip for its employees at his or her own discretion. These expenses are not directly related to the company's usual operational cost. These expenses should be adjusted in a normalized statement.