Net profits can be misleading

There are many types of profits that a company reports: operating profit, profit before exceptional items and taxes, net profits, etc. Each has its significance. Operating profit is calculated by using the company's revenue from operations and subtracting other operating expenses. It is also referred to as EBITDA (earnings before interest, taxes, depreciation and amortisation). No form of other income is taken into consideration for this metric.

'Profit before taxes and exceptional items' is a metric found further below in the income statement. It takes into account all operating and non-operating income and expenses but excludes exceptional items. And net profit is the final profit after taking into account all items. Since it is found at the end, it is also referred to as the 'bottom line'.

So, the net profit figure can be heavily impacted due to several factors, including exceptionals, taxes, and depreciation. Hence, it makes sense to dig deeper into net profits and not take them at their face value. Operating profit and profit before tax and exceptional items are a better metric of profitability than net profits. It doesn't mean that you should ignore exceptional items, taxes or depreciation. These do impact a company's financial condition and must also be assessed.

Case in point: Bharti Airtel
For FY20, the annual report of Bharti Airtel reveals that despite making a huge loss of Rs 36,088 crore, the company was actually profitable at an operating level (Rs 20,572 crore). The losses were a result of depreciation, finance costs and exceptional items.

Also in the series:
Look at the EPS, not just profits