Why are corporate profits important? Why do future profits matter?
A corporate profit is a statistic reported quarterly by the Bureau of Economic Analysis (BEA) that summarizes the net income of corporations in the National Income and Product Accounts (NIPA). Corporate profits is an economic indicator that calculates net income using several different measures:
- Profits From Current Production: Net income with inventory replacement and differences in income tax and income statement depreciation taken into consideration. Also known as operating or economic profits.
- Book Profits: Net income less inventory and depreciation adjustments.
- After-Tax Profits: Book profits after taxes are subtracted. After-tax profits are believed to be the most relevant number.
Because the BEA corporate profits number is derived from the NIPA (dependent on GDP/GNP growth), these profit numbers are often quite different from profit statements released by individual companies.
Corporate profit, also called net income, is the amount remaining after all costs, depreciation, interest, taxes, and other expenses have been deducted from total sales. Profit is also referred to as the bottom line, net profit or net earnings. The formula for profit is:
Total Sales – Total Expenses = Corporate Profit
Note that preferred stock dividends are typically included in the traditional net income calculation, but common stock dividends are not
BREAKING DOWN ‘Corporate Profit’
Because corporate profits represent a corporation’s income, they are one of the most important things to look at when investing. Increasing profits means either increased corporate spending, growth in retained earnings or increased dividend payments to shareholders. All are good signs to an investor.
Investors may also use this number in a comparative analysis. If an individual company’s profits are increasing while the overall corporate profits are decreasing, it could signal strength in the company. Alternatively, if an investor notices that an individual company’s profits are decreasing while overall corporate profits are increasing, a fundamental problem may exist.
Here is some information about Company XYZ for last year:
Using the formula and the information above, we can calculate that Company XYZ’s corporate profit was:
$1,000,000 – $500,000 – $300,000 – $100,000 – $5,000 + $1,000 – $10,000 – $10,000 = $76,000
This means that Company XYZ made $76,000 of corporate profit last year.
future profit matters because:
Philosophically speaking, corporate profit is what motivates industry, entrepreneurship and innovation. Adam Smith, the founder of modern economics, said, “It is not from the benevolence of the butcher, the brewer, or the baker, that we can expect our dinner, but from their regard to their own interest.”
Corporate profit is one of the most analyzed numbers a company can produce, and it plays a part in many other financial measures. It is important to understand that profit is not a measure of how much cash a company earned during a given period. The income statement, and hence net income, typically includes noncash expenses, such as depreciation. It is also important to understand that changes in accounting methods can greatly influence profit, and these changes may have little to do with a company’s actual operations.
Changes in corporate profit are the subject of much analysis. In general, low profit could suggest myriad problems, ranging from inadequacies in customer or expense management to unfavorable accounting methods; however, some companies strive to minimize taxes and will therefore intentionally minimize net income.
Corporate profit varies greatly from company to company and from industry to industry. Because profit is measured in dollars and companies vary in size, it is often more appropriate to consider profit as a percentage of sales (profit margin) when comparing one company to another. Care should also be taken when comparing profit over time, as many companies and industries are cyclical and/or seasonal. This is why comparisons are generally most meaningful among companies within the same industry, and the definition of a “high” or “low” net income should be made within this context.