Why calculating a business's bottom line is not so simple: Martin Towers

This is all urban mythology when we get to the bottom line. Because there really is no such universally accepted thing. Look at a profit and loss account and ask the accountant to describe and analyse the result. The unsuspecting might then be regaled with a number of different interpretations of the result, only mysteriously none of them actually includes the bottom line number.

Of course there is a reason for this. The absolute bottom line number is likely to be one we don’t like very much. It’s too low. Or could feature brackets and signal a loss. It is therefore quite likely that interpretation of the result features not the bottom line number but some other number further up the profit and loss account. This is achieved by excluding a number of items on a myriad of grounds. The most common are the items in question are non-recurring ‘one-off’ so should be ignored. Or exceptional in amount and nothing to do with day to day trading so should be excluded. Or irrelevant so should be stripped out.

An examination of the definition in a public company accounts of adjusted profit is likely to identify at least six separate adjustments off the bottom line. The upshot is a figure of adjusted profit much higher than the bottom line number, as not surprisingly items of profit do not call for downward adjustment. This adjusted profit is the one the company will use in analysing its performance and for example in determining the dividend policy. Who said accountants are not creative?

These various measurements of profit are absolutely within prevailing very prescriptive standards of profit measurement as espoused by accountancy bodies and their regulators in the UK and abroad.

These standards are themselves ‘tight’ having evolved tighter over the years. In tightening the rules they have inevitably become more complex and technical, none of which assists the reader of accounts. This renders accounts nowadays as virtually unintelligible even to the experienced reader and the average analyst.

Over the years the accountant has not always had it his own way in the world of adjustments.

Some more alert analysts started digging and got wise. Certain companies were called out, particularly acquisitive ones. Adjusted profits appeared inflated albeit technically not against the rules, in effect giving a misleading picture of true performance. The company was really in financial trouble and had resorted to financial engineering to paint a glossy picture and hide serious commercial and financial problems. However these problems usually come out sooner or later and for one reason. The measure of adjusted profit was miles away and way higher than the movement in cash.

The motto of the story is clearly follow the cash and relate whatever profit measure to cash flow. If they are not similar smell a rat, and definitely if they are moving in opposite directions. It can happen.

A simple concept such as the bottom line is anything but in the business world.

Martin Towers is the former finance director of Kelda Group, which was the parent company of Yorkshire Water, and former CEO of Spice PLC. He is now an early-stage business investor.