When a company announces their profit results they will usually declare a range of profit numbers such as underlying profit and statutory profit, making it all very confusing. But what do they all mean and which one should you pay attention to? In this article, we’ll try and explain all the relative numbers and which ones you need to keep an eye on.
A profit and loss statement
Here are the common profit measures:
- Gross Profit = Revenue – Cost of Goods Sold. It’s the profit a company makes after deducting the costs associated with making and selling its products or services.
- EBITDA – Stands for Earnings Before Interest, Tax, Depreciation and Amortisation. It is used to analyse and compare profitability between companies and industries because it eliminates the effects of financing and accounting decisions. EBITDA = Net Profit + Interest +Taxes + Depreciation + Amortization.
- EBIT – Is simply EBIT minus deprecation. EBITDA calculates earnings before any depreciation or amortization is determined whereas EBIT with operating income. Indeed, these values are often so closely related they can be used interchangeably without causing any accounting issues.
- NPAT – Net profit after tax is one of the more important figures that a company will disclose. The NPAT is calculated from taking the operating profit after income tax, before the significant and extraordinary items. The formula is NPAT = EBIT – tax.
- PBT – Profit before tax.
- Net Income – This is the bottom. Net income is a company’s total profit. It’s what goes to shareholders and is used for PE multiples. It is calculated by taking revenues and subtracting the costs of doing business such as depreciation, interest, taxes and other expenses.
- Statutory profit – Is calculated by adding one off gains (or losses) to underlying profit. This is a once off and doesn’t happen every year. For example a company may sell some of its assets. Therefore the statutory profit isn’t the figure used by analysts to compare. Most strategic decisions are taken based on underlying profit figures.
- Operating profit – Is the profit earned from a firm’s normal core business operations. This value does not include any profit earned from the firm’s investments, such as earnings from firms in which the company has partial interest, and the before the deductions of applicable interest and taxes owed.
- Normalised profit – Are adjusted profits to remove the effects of seasonality, revenue and expenses that are unusual or one-time influences. Normalized earnings help business owners, financial analysts and other stakeholders understand a company’s true earnings from its normal operations.
- Operating Profit – Is the income earned from the core operations of a business, excluding any financing or tax-related issues. It is used to explore the profit-making potential of a business, excluding all extraneous factors.
The most important metric however is Underlying Profit. It is what analysts use to compare their forecast against. So when you hear a company has beaten profit expectations, they are comparing the underlying profit with their forecasts. When analysing a bank’s profit against expectations, the figure used is cash profit instead of underlying profit. The underlying profit shows how the business is performing. This amount is an indication of what a company may do year after year if all other parameters remain same. Australian companies are required to report statutory numbers but they will use underlying profit numbers to exclude one-off items and paint a rosier picture. The thing to keep in mind is that profit and loss figures can be manipulated to look a lot better than they really are. So as well as profit, look at free cash flow as well. Free cash flow is a measure of a company’s financial performance, calculated as operating cash flow minus capital expenditures. It is the cash that a company generates after spending the money required to maintain or expand its asset base. It basically shows how profitable a business is and tells a lot better story than most of the other metrics. The profit and loss statement spreads out cash spend on long term investments over time whereas the cash flow statement has no smoothing. It’s all about the current position, what is spent here and now. Ultimately underlying profit and cash flow are just metrics and may not tell you the whole story. Just because a company isn’t generating a profit, doesn’t mean its share price won’t go up i.e. – Xero (XRO). It’s all in the expectations of future earnings that matters and whether a company will meet those expectations that matters most.