Investor Research To Be Made Easier By New International Standard On Operating Profit Reporting
Anyone investing online and picking stocks themselves will be familiar with the problem of different companies using different methodologies to measure their operating profit figures. Not only can it mean using stock screening tools to filter companies using operating profit as a metric is inefficient, it also makes manually assessing the figure a time consuming process. What methodology does a particular company use and what is the reality underneath that headline figure? Has a ‘flattering’ definition been opted for?
But, thankfully, operating profit creativity looks like it will soon cease to be an irritation for investors. The International Accounting Standards Board (IASB) yesterday announced that it intends to set a single international standard that all public companies will be obliged to adhere to when they report their operating profit figure. The decision has been informed by recent research carried out by the Board. It revealed that a sample of just 100 companies used 9 different ways to calculate their operating profit.
The IASB sets and regulates accounting standards in more than 140 countries. The UK is among them, though not the USA. So unfortunately the new standard won’t apply to companies listed on U.S. exchanges. Currently, the IASB’s rules apply to how top line revenues and bottom line profit and loss figures are defined. But until now they have not required standardised definitions and methodologies for how all of the sub-total figures in between are calculated.
That’s problematic for investors, who consider sub-totals such as operating profit key metrics when assessing the financial health of companies whose shares they are looking at. Companies themselves consider operating profit as a key performance metric.
Explaining the move yesterday, IASB chairman Hans Hoogervorst commented:
“Operating profit of one company cannot be compared with the operating profit of another company.”
He went on to describe that state of play as “a very unsatisfactory situation”. The inconvenience not only effects investors. It is also a factor for company boards, whose members often sit on more than one board at a time, or at different points in time. That means they have to understand how each separate company they are overseeing calculates their particular operating profit figure.
The Board will also propose companies under its jurisdiction be required to provide an additional two profit measures in their income statements - “operating profit and income and expenses from integral associates and joint ventures” and “profit before financing and income tax”.
“Non-GAAP” metrics such as adjusted earnings before interest, taxes, depreciation and amortisation are also to be more standardised if the IASB gets their way. Mr Hoogervorst commented on that topic:
“The truth is that investors often find those non-GAAP measures useful so we do not aim to root them out. However, what we aim to do is to provide a little bit more discipline and transparency around the use of non-GAAP.”
If the Board’s plans are confirmed after it completes a consulting period, the new rules will come into force in 2023. Something Mr Hoogervorst believes will be a “game-changer in financial reporting”.
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