ADJUSTED NET INCOME APPROACH Meaning and
Definition
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The adjusted net income approach is a valuation method used in financial analysis to determine the worth of a company or investment. It involves calculating the adjusted net income of a business by making various adjustments to its reported income figures to reflect the true economic value of its operations.
The approach starts with the company's net income figure, which is obtained by deducting all operating expenses and taxes from its revenue. However, this reported net income may not accurately represent the economic reality as it may include non-recurring or extraordinary items that are not expected to occur in the future.
To arrive at the adjusted net income, certain adjustments are made to the reported net income. These adjustments can include removing non-recurring expenses or gains, such as one-time legal costs or the sale of a non-core asset. Additionally, adjustments may be made for discretionary expenses, such as excessive executive compensation or non-operating income or expenses that are not related to the core business activities.
By adjusting the reported net income, the approach aims to provide a more accurate representation of the company's ongoing earnings potential. This adjusted net income figure is then used in various financial analyses, including determining the fair value of the company's shares or assessing its profitability and financial health.
Overall, the adjusted net income approach assists in evaluating the true earnings power and value of a business by removing distortions caused by non-recurring or non-essential items, leading to a more accurate assessment of its economic worth.
