All about op­er­at­ing profit

Most firms do not dis­close op­er­at­ing prof­its sep­a­rately. So, how can you cal­cu­late it?

The Hindu Business Line - - YOUR MONEY - SATYA SONTANAM

Op­er­at­ing profit, or re­cur­ring profit, is a key met­ric used to an­a­lyse the prof­itabil­ity of the core busi­ness of any com­pany.

It is the amount of profit re­alised af­ter de­duct­ing op­er­at­ing ex­penses such as cost of goods sold, em­ployee ex­penses and other re­lated ex­penses that are di­rectly linked to the op­er­a­tions of a firm from the rev­enues aris­ing out of the its op­er­a­tions.

When com­pa­nies re­lease their quar­terly or an­nual profit and loss state­ment, they do not usu­ally dis­close op­er­at­ing prof­its sep­a­rately. An ac­cepted way of cal­cu­lat­ing op­er­at­ing profit is by adding fi­nance cost, and de­pre­ci­a­tion and amor­ti­sa­tion costs to the profit be­fore tax (PBT) re­ported by the com­pany, and de­duct­ing the other in­come, if it is in­cluded in the top-line.

Other in­come is the in­come de­rived from, say, in­vest­ments made by a com­pany.

As it is not earned from the com­pany’s busi­ness op­er­a­tions, it needs to be de­ducted.

In some cases, EBIT (earn­ings be­fore in­ter­est and tax) is deemed as op­er­at­ing profit of a firm. EBITDA (earn­ings be­fore in­ter­est, de­pre­ci­a­tion, tax and amor­ti­sa­tion) is also widely used to rep­re­sent op­er­at­ing profit.

Changes in op­er­at­ing profit should be an­a­lysed closely. For ex­am­ple, JSW Steel’s to­tal sales vol­umes in the quar­ter ended De­cem­ber 2018 fell 10 per cent from the year-ago pe­riod. But this didn’t lead to a drop in the op­er­at­ing profit of the com­pany in the said quar­ter as the re­al­i­sa­tions had im­proved from ₹ 46,000 a tonne to ₹55,200 a tonne.

Fur­ther, op­er­at­ing prof­its are also im­pacted by changes in op­er­a­tional costs.

For in­stance, ACC Ce­ment’s rev­enues in the third quar­ter of FY19 im­proved 11 per cent y-o-y on ac­count of an in­crease in sales vol­umes and sta­ble re­al­i­sa­tions. The op­er­at­ing profit grew only 10 per cent due to in­crease in costs. A high op­er­at­ing profit in­di­cates healthy op­er­a­tional per­for­mance and that the com­pany will be able to meet its dues to its cred­i­tors and bor­row­ers from the in­come gen­er­ated from its pri­mary busi­ness ac­tiv­i­ties.

Op­er­at­ing mar­gin

Op­er­at­ing profit mar­gin is a prof­itabil­ity ra­tio that mea­sures the per­cent­age of op­er­at­ing profit in the to­tal rev­enue earned by a firm. It is de­rived by di­vid­ing the op­er­at­ing profit by the rev­enue ac­counted for in a cer­tain pe­riod. Even if there is an in­crease in the amount of op­er­at­ing profit in a cer­tain pe­riod, mar­gins could be un­der pres­sure.

An anal­y­sis of op­er­at­ing mar­gin helps in peer com­par­i­son of com­pa­nies as it gives a clear pic­ture on how sale prices and costs are main­tained.

For ex­am­ple, Tata Steel and JSW Steel recorded op­er­at­ing mar­gins of 34 per cent and 24 per cent, re­spec­tively, in the quar­ter ended Septem­ber 2018. The lower op­er­at­ing profit of JSW Steel is due to the pur­chas­ing cost of the raw ma­te­rial, iron ore. While JSW Steel buys most of its raw ma­te­rial from third par­ties, Tata Steel saves on that as it has its own iron- ore mines.

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