Analysing Profitability

By Prof Arun Kumar Agarwal, ACA, ACS

IBS, Gurgaon
 Profitability Analysis

Profitability is one of the most important Key Performance Indicators of a

Business Enterprise for the following reasons:
i. For Continuity: a business to remain in existence it must be profitable. A
losing business can never hope to remain in business for long;

ii. Contribution to society: in the form of employment, taxes, industrialisation

through a network of ancillaries & vendors, return to investors in the form of
dividends and appreciation in investment;

iii. Delivering consistently increasing shareholder value which is the key

objective of any business.
 Profitability Analysis

Profitability Analysis is done by a critical analysis of the Statement of Profit and

Loss of a Business which forms part of its Financial Statements.
 Statement of Profit & Loss - Content
Determination of Profits / Operating Efficiencies

From Sale of Goods &

Services;
Income/
Revenue
Other Operating Income such
as sale of scrap;

Other income such as rentals,

interest & Dividends on
investments’

Current Expenditure: Material Consumed + Manpower Cost + Administrative Cost +

Marketing & Distribution Cost + Finance Cost

Provisions& Non Cash Expenditure: Depreciation + Expenses incurred but not paid

Extraordinary Items: These can be both income or expenditure related and are of a non
recurring nature, having arisen during the current financial year due to unique
circumstances.
 Some Key Elements in the Statement of Profit & Loss

Sales or Operating Revenue: income arising from the main line of activity
of the business. Thus for Maruti Suzuki Ltd, the income from sale of cars will
fall in this category.

Revenue or Other Operating Income: Income from peripheral business activities, such
as, sale of scrap, sale of FAs
Income

Other Income: This is income from activities not pertaining to the main line
of business, such as, interest & dividend income, profit on sale of investments
etc

Direct Operating Expenditure: Cost of materials consumed, cost of direct

manpower, direct costs such as power & fuel, repairs and maintenance of
P&M etc

Expenses Overheads: Finance Cost, Administrative and selling expenses, cost of

indirect manpower

Non Cash Charge – Those exps which are incurred but no cash outflow
takes place such as depreciation, provisions etc
 Some Key Elements in the Statement of Profit & Loss

Treatment of “Exceptional Items” in Statement of Profit & Loss

Exceptional Items are those incomes and expenditures which are not incurred in the
normal course of business but which arise as a “one off“. Such items may be both
incomes or expenses and are treated accordingly in the Statement of Profit and Loss.

Examples:
 Profit or Loss arising from the closure of a business / subsidiary
 Loss arising from impairment of a capitalized asset such as property, plant and
machinery or some intangible asset
 Employee separation cost such as VRS etc
 Provision made for impairment of investment in a subsidiary company
 Etc

Treatment in Financial Analysis

 The impact of Exceptional Items should be excluded in the analysis of profitability
of a business as such incomes or expenditures are not routing in nature and
hence if considered, will distort the conclusions.
 In Inter Company analysis will give misleading conclusions
We shall do the Financial Statement Analysis of
Companies in a later chapter..
Thank You…