Defining Underlying Profit

Underlying profit meaning is defined as an unofficial profit calculation that is made internally by an organization because it believes that the figure portrays the company’s actual state more accurately than any standard Accounting metric, like net profit or the ROI of the business.

The company may then choose to report the underlying profit margins together with their official financial statements comprising reports of the Earnings generated in a specified format as required by law.

The underlying profit numbers focus on the standard Accounting Cycle events, which often excludes the infrequent occurrences or one-time charges.

People often confuse the underlying profit with the required accounting profit recorded on the official documents and financial statements that follow preset rules, regulations, and practices; however, they are different.

Every company has its own underlying profit version, and takes the accounting profit to make further adjustments as required.

How to Calculate the Underlying Profit Metric?

After the companies publish their financial reports, GAAP (Generally Accepted accounting principles) require them to disclose the profit they have generated.

One can calculate the net profits by subtracting all the expenses and costs from the total revenue earned. You can use the same calculation to estimate the total amount of income tax to pay. However, as mentioned earlier, you must exclude all the one-time profits and losses, and extraordinary and non-recurring expenses while calculating the underlying profit.

Underlying profit opposed to what we know as “statutory profit”, which is the profit figure required to publish in the annual Income statement of the company.

Let’s take an example. Say a company has full ownership of two apartments, and one is in use at present. Suppose the company chooses to sell the vacant building. Then the company may record the sale of this asset in standard accounting statements. However, it should be excluded while calculating the underlying profit.

Advantages and Disadvantages of Underlying Profit

Underlying profit comes with its own pros and cons. Let’s have a look at those aspects.

Advantages

• Underlying profit gives investors an estimate of the profit a company makes from its regular business operations.
• It enables the management to do informed business planning and make data-driven marketing strategies. This business plan also indicates the expected expenses to be covered over a given time period.
• A business may want to remove any irregular or one-off financial gains or transactions, which often tend to inflate the profit norms wrongly. It will help to determine the operating costs to be covered more reasonably and accurately. Hence, the underlying profit helps to create a plan based on recurrent occurrences that one can anticipate rather than irregular ones.
• The underlying profit figure, alongside other financial statements, enables investors to decide whether to invest in a particular company.

Disadvantages

• Every company comes with its own individual version of underlying profit. It is because most of them prefer taking the accounting profit first and then making the necessary adjustments according to their needs. However, this can be faulty at times. So, clear guidance is required to help businesses report the underlying profit more accurately.
• Full freedom often leads to inaccurate or falsified calculations.
• Investors must recognize the difference between underlying profit and accounting profit, and also get a solid understanding of how the former is estimated. However, companies generally disclose this information in their financial statements, and investors often don’t get the true profit margins at hand.

So, it’s advised that one should take the underlying profit figure with caution and determine the exact reasons behind certain expenses being ignored while calculating the Face Value of the figure.