Monday, August 21, 2006

More Net Profit

Net Profit may be subjected to multiple rounds of creative accounting (i.e. legally faking no.s or cooking the books to produce no.s) but it does measure the profit that should go to shareholders. To put it into another perspective, if the company has integrity and assuming that it does not cook its books, then Net Profit is a true measure of the profit attributable to shareholders.

As a rule of thumb, Net Profit should be 50-70% of Operating Profit. This is worked below:

Assuming that a company has $100 in operating profit, then

Operating Profit $100
Recurring Profit $90 (say interest expense is 10% of OP)
No XO loss or gain as it should be
Tax rate 20% (i.e. tax is $18)
Net Profit $72

Hence a good co. would have a Net Profit of roughly 50-70% of OP, depending largely on the tax rate. In Singapore, however, there are a few companies that has Net Profit that is greater than Operating Profit. This is usually because they have a lot of profit gained after OP like sale of investment in stocks, properties or simply income from cash holdings.

The most prominent example is SPH. For several years, SPH sold various investments that it held in Singapore stocks like Starhub, M1 etc. These huge gains from investments are allocated at the Recurring Profit level and hence even after taxes are deducted, Net Profit is much higher than it should be, sometimes even higher than OP.

See also P&L Reloaded: Net Profit
and P&L Statement
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