What is Underlying Profit?

What is Underlying Profit?

Let me explain underlying profit to you directly: it's a calculation I see companies make internally to present what they believe is a more accurate picture of their earnings. This figure zeros in on everyday accounting events and typically leaves out one-time charges or rare happenings. Unlike the official accounting profit that appears on financial statements and follows strict rules and regulations, underlying profit is more flexible.

Key Takeaways on Underlying Profit

Here's what you need to grasp: underlying profit is something companies compute inside their walls to reflect what they see as their true profit status. It emphasizes routine accounting cycles and often skips over one-off charges or unusual events. Remember, every company tweaks this their own way, starting from the accounting profit and adjusting as they deem necessary.

How Underlying Profit Works

When companies release their financials, GAAP demands they report profit by subtracting all costs from revenue—the same method used for income taxes. But often, they'll add their own spin with underlying profit to give a better sense of ongoing performance year after year. By removing oddball, non-recurring costs like damage from a natural disaster, it smooths out the bumps and helps you, as an investor, understand how profits from standard operations fluctuate over time.

Companies use these figures for planning too—the idea is to cut out noise from random events. Things like restructuring costs or property sales get ignored because they're not regular and don't show the daily grind of running the business. Generally, only predictable operating expenses get deducted from sales to reach underlying profit, such as personnel costs like payroll and training, which are foreseeable; facility expenses including rent, utilities, and insurance, set by contracts; technology upkeep like software maintenance; and asset replacements.

Example of a One-Time Event Removed for Underlying Profit

Take this scenario: if a company owns two buildings, one in use and one empty, and decides to sell the vacant one, that sale goes into standard accounting records. But for underlying profit, it's excluded. Why? Selling a big asset isn't part of normal operations and won't happen again soon—it's a one-off gain that doesn't repeat in future cycles.

Advantages of Underlying Profit

Beyond showing investors what a company earns from its core activities, underlying profit aids management in planning. A business plan acts as your roadmap for operations, especially for startups, and it outlines expected expenses over time. When figuring out what costs can be covered, it's smart to strip out one-time or irregular transactions that might skew the picture, basing the plan on typical, predictable events instead.

Disadvantages of Underlying Profit

The downside is that each company defines underlying profit their own way, adjusting accounting profit as they please, with no standard rules. This makes comparing companies unreliable. Sometimes, firms exclude negative items quarter after quarter and push underlying profit as the key metric, which can be questionable. As an investor, you must distinguish it from accounting profit, understand the calculation—companies disclose this in statements—and use it cautiously alongside other data. Check why certain expenses were omitted before accepting it outright.