How companies can present their results in the best light

Friday 1st February 2002

The securities industry's use of different types of "earnings" for analytical purposes has given listed companies the opportunity to emphasise those that present results in the best light.

They still have to report interim and final results in the format the Stock Exchange has decreed but can use imagination in the comments department.

The Stock Exchange's reporting form has a bottom line described as "operating surplus (deficit) and extraordinary items after tax attributable to members of the listed issuer."

It is effectively net profit after tax, including unusual and extraordinary items and minority interests, and is the figure in which most shareholders and other observers are interested.

They may add back unusual and/or extraordinary items if the latter are one-offs and distort the operating results.

Earnings per share and the various ratios used to assess company performance have traditionally been calculated from that information.

It was used to compare companies with others in the same industry sector and across sectors.

Some analysts wanted to compare profit performance on a basis that excluded items unrelated to the basic business that were irrelevant to particular ratios or imposed from outside and/or highly variable.

There is an argument, for example, that interest paid on borrowings is extraneous to the basic business and is significantly variable because interest rates can change considerably between years and within a year.

Maybe, but there is also the counter-view that interest, like tax, is a cost of doing business.

Tax is an outside imposition and relates, in dollar terms, to the business's operational activities only to the extent of dollar movements in pre-tax profit.

The dollar charge is reached after taking allowable deductions and non-taxable income from pre-tax profit and can therefore be variable as well as an outside charge.

We thus get that wellknown acronym ebit, earnings before interest and tax.

That is a useful figure from which to calculate returns on assets, although adjustments may need to be made to the book value of assets to give realistic assessments.

Removal of interest and tax also provides a guide to operational performance. It can be a useful figure for companies' high borrowings and correspondingly high interest costs relative to the total size of the organisation because it could boost "earnings."

Even ebit was not enough for some people, so "ebitda" was developed: earnings before interest, tax, depreciation and amortisation of intangibles, particularly goodwill.

It is a useful base from which to calculate a company's margins on sales after allowance for basic operational overheads and is used in promotional material including prospectuses and investment statements.

Different uses of the various "earnings" concepts and the order in which they were used were seen in reports to the Stock Exchange in January.

Fastfood operator Restaurant Brands referred first to its net profit after tax and abnormals for the year ended November 30. The company next stated profit after tax, but before abnormals, for the second six months.

References to ebitda followed, including calculations of ebitda margins for the constituent businesses: KFC (Kentucky Fried Chicken), Pizza Hut and Starbucks Coffee.

Appearance medicine company Caci and telecommunications operator CableTalk Group reported their inaugural results by referring first to ebitda, in line with the layout of their forecasts when floating.

Medical and healthcare service provider ElderCare's profit announcement for the six months ended November 30 was headed "ElderCare lifts performance to show ebit profit for half year."

The company stated its net profit after-tax result in the fourth paragraph of the report.

Eldercare said ebit was $1.42 million, compared with an ebit loss of $4.66 million in the same period of the previous year.

Chairman Jim Syme said net profit after tax was a loss of $842,000 and described that result as a vast improvement on the loss of $6.55 million reported for the first six months last year.

The latter figure included unusual items of $5.3 million as a writedown on discounted property developments and other assets and a realised loss of $1.3 million on the sale of the company's holding in another organisation.

Eldercare's reported operating surplus/deficit before unusual items and tax was a loss of $720,000 compared with a profit of $93,000 in the corresponding half of the previous year.

Those figures were struck after the group took up $2.14 million of interest expense in the first six months of the current year and $1.88 million in the November 2000 half.

Eldercare capitalised another $466,000 in the latter period.

Comments accompanying reports to the Stock Exchange are a company's business, provided they are not incorrect, misleading or false. There is a strong case for references to various forms of profit/earnings to follow the reporting form's format, whether from the bottom up (net profit back to revenue) or the top down (revenue to net profit).

Figures for ebit, ebitda and other concepts can be added in so they do not obscure the final outcome after interest, unusual items, depreciation, tax, amortisation and any other debits to the statement of financial performance.

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