What is an Underlying Profit
An underlying profit describes an actual reflection of a company's profit, where the underlying profit is not necessarily the required accounting profit that is recorded on financial statements and other mandatory documents that follow preset practices, rules and regulations. This number is calculated internally by a company to show what it believes to be an accurate reading of its profit position and may exclude one-time charges or infrequent events.
The calculation of underlying profit is therefore going to be different for every company, even though pro forma accounting calculations will be done quite similarly for all companies following the same accounting standards. The calculation begins with the accounting profit and then 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 profit can be compared between companies. When dealing with financial reporting, the accounting profit will need to be used for tax and analysts' purposes. The underlying profit is incomplete and is used for internal business planning only.
BREAKING DOWN Underlying Profit
Business Planning and Underlying Profit
A business plan is a functional road map providing direction as to how the company will operate, and is often the founding document drafted by new ventures. From an accounting perspective, the business plan also denotes the 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 that can be anticipated.
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 because salaries are often negotiated in advance and training costs are known from prior experience. Facility expenses, including rent or mortgage payments (if applicable), utilities and insurance also qualify because costs have been pre-established by contract or other agreement. Technology-related expenses, including software maintenance and upgrades, and asset replacement are often considered to be operating expenses as well. All these expenses would be included as deductions from gross sales in order to arrive at the underlying profit.
Example of a One-Time Event Removed for the Calculation of Underlying Profit
If a company is in full ownership of two buildings, and one is currently in use while one is 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 and is not expected to occur again soon. Though it has resulted in a form of income, it is not likely to be repeated in subsequent accounting cycles for the company.