Investment School. All about operating profit

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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