Underlying Profit
Overview
Underlying profit is a company’s internal measure of profit intended to reflect earnings from its regular, ongoing operations. It adjusts the statutory accounting profit by removing one-off, unusual, or infrequent items so that year‑to‑year operating performance is clearer.
How it works
Statutory profit (reported under GAAP or other accounting standards) includes all revenues and expenses required by those rules. Underlying profit starts with that accounting profit and then makes management-determined adjustments to exclude items considered non-recurring or not part of normal operations. The goal is to present a steadier view of operational performance by smoothing out distortions caused by exceptional events.
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Common adjustments
Companies vary in what they exclude, but typical adjustments include:
* One-time gains or losses from asset sales (e.g., selling a building)
* Restructuring costs or severance payments tied to a specific reorganization
* Impairment charges for non-operational assets
* Costs or losses from natural disasters or other major one-off events
* Large litigation settlements or settlements that are not part of ordinary business
Regular operating costs generally left in the underlying profit calculation include:
* Personnel expenses (payroll, routine training)
* Facility costs (rent, utilities, insurance)
* Technology and maintenance costs
* Asset replacement costs that are part of ongoing operations
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Example
If a company sells a vacant building it owns, the accounting profit must reflect the gain from that sale. For underlying profit, management may exclude the gain because the sale is not part of the company’s normal operating cycle and is unlikely to repeat in future periods. Excluding it aims to show profit from core business activities only.
Advantages
- Provides a clearer view of recurring operational performance by removing one-off events.
- Useful for internal planning and budgeting, helping management focus on predictable expenses.
- Can help investors and analysts assess trends in the core business when used alongside statutory figures.
Disadvantages and limitations
- No standardized definition—companies choose their own adjustments, so underlying profit is not directly comparable across firms.
- Potential for management to exclude recurring or material items to present a more favorable picture.
- Can be misleading if investors do not review the reconciliation between statutory profit and underlying profit.
Practical guidance
- Always review the company’s reconciliation from accounting profit to underlying profit to see which items were excluded and why.
- Use underlying profit as a supplement to, not a replacement for, statutory financial statements.
- Compare trends in both underlying and accounting profit over several periods to identify whether adjustments are masking recurring issues.
Key takeaways
- Underlying profit isolates recurring operational performance by excluding unusual or non-recurring items.
- It can be a valuable analytical tool, but lack of standardization requires careful scrutiny of the adjustments.
- Combine underlying profit with statutory measures and disclosures to form a robust view of a company’s financial health.