Underlying earnings, also known as underlying profit, are used by companies to present their earnings in a more accurate format than that of statutory profit metrics. Statutory profit is the traditional form of profit, which companies are required by law to report within their official financial statements. This form of profit calculation includes all one-off payments and exceptional gains.
Underlying earnings help to give more accurate year-by-year figures, by removing non-recurring costs and one-off losses/gains from the equation. This helps to ensure that only the regular, everyday costs are reflected within the final figure to give a more stable and consistent show of earnings. These figures are usually stated by a business alongside their official financial statements, which show in the traditional way how much profit has been generated.
How do companies calculate Underlying Earnings?
Companies can calculate underlying earnings by reviewing any losses or gains that are not recurring and are not part of day-to-day business operations. These figures, along with usual expenses, should then be subtracted from revenue to determine profit.
Some of these one-time gains/losses are unexpected and would not have been forecast. Typical deductions include:
- Money from the sale of property or land
- Charges from unexpected damage to property
- Charges from restructuring
- Money from the sale of large assets
- Charges from relocation
Using Underlying Earnings for business plans:
Company directors may also choose to calculate underlying earnings for business planning. A business plan is a written document that lays out financial planning, budgets, marketing strategies and an executive summary. It helps companies to have a more strategic approach to completing their goals and objectives.
Having a more regular, stable insight into year-by-year earnings, can help businesses to plan more accurately for the future. The business management team may choose to use underlying earnings to ensure they are not forecasting unreasonably high statistics.
What are the advantages and disadvantages of Underlying Earnings?
There are both advantages and disadvantages to using underlying earnings. These should be taken into account when deciding whether to include them. It is important to ensure that underlying earnings are accurate and will be beneficial for the particular company/investor.
- Allows for a more accurate display of earnings — the deduction of non-recurring expenses gives a clearer picture of the normal year-to-year earnings of a company.
- Useful for planning — underlying trends can be made clear without being distorted by large one-off gains or losses, which is especially helpful when planning.
- Helpful for investors — underlying earnings enable investors to clearly see how much a company is earning from their day-to-day operations, before making any investment decisions.
- Inconsistent between companies — each company will have their views on what should be excluded and included within underlying earnings. This can make it difficult to compare companies against one another.
- Can be inaccurate — some companies use underlying earnings as a way of hiding large losses and making the business appear more profitable than it actually is.
- Uncertainty over the calculation — it is important that there is an explanation given for why certain expenses have been deducted, otherwise, there can be confusion and a lack of trust.