Underlying Profit

Categories: Accounting

You run a company that produces robot animals for zoos that are tired of the trouble of feeding their exhibits. This year, you launched a major expansion in your penguin division. It cost $5 million. At the end of the year, you reported an annual net loss of $2 million. However, that number included the $5 million you spent on the penguin upgrade. It's not an event that will likely repeat (you aren't upgrading your penguin division every year). Plus, it should only add to your profits going forward.
So, for making business decisions, that $2 million loss doesn't mean much. Sure, you did, in fact, lose $2 million during the year. But that doesn't mean you had a bad year. You just spent a lot of cash to upgrade your business.

Instead of looking at the bottom line number, therefore, you choose to focus on the underlying profit. It's the amount you would have earned, if not for that one-time cost for expansion. If you had skipped the penguin upgrade and just let normal business take its course, you would have earned $3 million for the year. That number (the underlying profit) better exemplifies the overall potential of your business. Assuming all the conditions stay the same next year, you're much more likely to earn $3 million than to lose $2 million.

That situation exemplifies the use of underlying profit as a concept. It represents what the business produces, leaving out one-time items. It's the number used for business and investing purposes, rather than the official numbers that get sent to regulators or the IRS.

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