Revealed: What net profit actually is

Fsp Invest, 07 Nov. 2013

Tags: net profit, company profits, profits, investing, retained profit, dividends pay-out ratio, what is retained profit, what is net profit, earnings per share, eps

When you read about a company’s financial performance, one thing you want to keep an eye on is profits. But if you have a look at a company’s financial reports, you’ll notice there are different ‘types’ of profit. One important type is net profit. Read on to uncover exactly what net profit is…

Once a company has knocked off financing costs and tax, you hit the profits after tax – or ‘net’ profits – line, Tim Bennett in MoneyWeek explains...

This is the number from which a firm’s directors pay the dividend. It is also the number that goes into the well-publicised earnings per share (EPS) number at the foot of the profit and loss account.

EPS is just the net profit number divided by the number of shares in issue. It is also often a number the directors want you to focus on, so it’s important to be a bit sceptical.

In fact, as a rule of thumb, if the directors draw your attention to any particular profit figure, or any other number for that matter (by boxing it out, for example, or highlighting it near the top of the accounts) be especially wary. It’s likely to be the one that flatters them the most.

Check the pay-out ratio

On net profit – particularly if you are looking to buy an income stock – always check the pay-out ratio. This is the proportion of this year’s net profit the company pays out as dividends.

If profits are R100 million and the annual dividend is R20 million, the pay-out ratio is 20%.

All else being equal, the lower the better. Too high and pay-outs may not be maintained, meaning there’s less scope for dividend growth.

Once a company has knocked off all its costs, including any dividend it pays, you get ‘retained’ profit. This is what the company keeps as a buffer for future years. This matters because, subject to accounting tweaks, a firm can pay out cumulative past profits as dividends.

So there you have it, what net profit actually is.

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