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What Exactly Is “Net Profit?”

Struggling with financial analysis is difficult enough for those not trained in finance. It is even more difficult when the terminology is not uniform.

"Net profit" does not always mean the same thing. The danger is accepting this term and assuming it is always the same number is that you might end up making comparisons between two or more companies (or within one company between two or more fiscal years) using dissimilar numbers.

Most analysis of net profit and the closely associated net return ratio (dividing net profit by revenues) is based on the net operating profit. This is the amount of money left over after deducting costs and operating expenses. However, there is another "net profit" that adjusts for "other income" and "other expenses." These include interest, capital gains or losses, currency exchange, investment income or loss, and many other possible non-operating adjustments to the bottom line.

Even beyond this is the post-tax net profit. This is the true "bottom line" everyone has heard about. It is the net profit minus the federal income tax liability for the year. The terminology should be uniform but it is not always the case. Here is a summary of the various forms of profit used in the income statement:

Revenue (Sales) xxxxxxx

Minus: Cost of goods sold

(This includes purchases of

merchandise for resale,

changes in inventory level,

freight, and other costs

directly related to sales -xxxxxx

Gross profit xxxxxxx

Less: general and administrative

expenses (overhead) -xxxxxx

Net operating profit xxxxxxx

Plus or minus:

Other income and expenses -xxxxxx

Net pre-tax profit xxxxxxx

Minus: liability for federal

income taxes -xxxxxx

Net after-tax profit xxxxxxx

So when you see the term "net profit" or "net earnings," make sure you know which one of these sub-totals is being employed. Also make sure the same number is used in comparisons between companies.

Further complicating this analysis is yet another adjustment, to arrive at "core earnings." This adjustment was created by Standard & Poor's Corporation to adjust reported net profit to remove non-recurring items from the income statement, or to add in forms of operating income not normally included. The computation is complex, but it often makes a big difference in what actually is reported. Unfortunately, adjustments to arrive at core earnings are not accepted widely and few finance managers pay attention to it. The best place to see the difference is on the S&P Stock Reports, where net earnings is followed by core net earnings in the annual summary of operating results.

Any form of financial analysis relies on consistency and accuracy. Even with the many flaws in the U.S. accounting and auditing system, the intended purpose of the accounting rules is to strive for consistency in how the numbers get reported to investors. Unfortunately, that goal is not always reached.

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