What is an ‘Underlying Profit’
An underlying profit describes an actual reflection of a company’s profit. The underlying profit is not the required accounting profit that is recorded on financial statements and documents mandatory to follow preset rules and regulations. This number is calculated by the company to show what it believe to be an accurate reading of the company’s profit position and may exclude one-time charges or infrequent events.
Explaining ‘Underlying Profit’
The calculation of underlying profit is different for every company. It begins with the accounting profit and makes adjustments as it sees fit. In recent years, it has been argued that there should be some kind of guideline in place so that the reporting of underlying profits can be compared between companies.
Business Planning and Underlying Profit
A business plan is a functional road map providing direction as to how the company will operate. From an accounting perspective, it also denotes any expected expenses that must be covered over a particular period of time. When determining what operating costs can be reasonably covered, a business may prefer to use its underlying profit calculation, which removes any one-time or highly irregular financial transactions that may falsely inflate profit norms. This creates a plan based on more common occurrences.
Regular Operating Expenses
Regular operating expenses involve a variety of areas, covering any form of expense that can be considered predictable or required. Personnel expenses, including everything from payroll to training, are often considered to be operating expenses. Facility expenses, including rent or mortgage payments (if applicable), utilities, and insurance qualify. Technology-related expenses, including software maintenance and upgrades, and asset replacement are often considered to be operating expenses.
Example of a One-Time Event Removed for the Calculation of Underlying Profit
If a company is in full ownership of two buildings, one currently in use and one sitting vacant, it may choose to sell the vacant building. While the sale of this asset must be recorded for standard accounting purposes, it is excluded from the calculation of underlying profit. The sale of a large asset, such as a building, is not a standard part of the business’s operation. Though it has resulted in a form of income, it is not likely to be repeated in subsequent accounting cycles for the company.
Further Reading
- Underlying profit in New Zealand – www.emerald.com [PDF]
- Ethical screening in modern financial markets: the conflicting claims underlying socially responsible investment – www.jstor.org [PDF]
- Do large Australian companies emphasise non-GAAP financial measures over statutory net profit (GAAP) in annual reports? – search.informit.com.au [PDF]
- Rational Investments, Speculation, or Gambling–Derivative Securities and Financial Futures and Their Effect on the Underlying Capital Markets – heinonline.org [PDF]
- An Examination of the Underlying Rationale of the Profit and Loss Sharing System, With Special Emphasis on the Mudarabah and Musharakah Within the Context of … – search.ebscohost.com [PDF]
- Capacity utilization measures: underlying economic theory and an alternative approach – www.jstor.org [PDF]
