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5 things to know about Exceptional Items in company Balance Sheets
Reading and analyzing a company’s business is no less than an art. It needs careful understanding, especially when you are using it to invest in stocks. It’s not enough to just compare the growth in profits and revenue. It is equally important to know if the trend will continue. For this, one of the things to look for is ‘Exceptional Items’.
In the quarter gone by, a lot of companies reported Exceptional items in their balance sheets. Here’s what you can make of it.
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What are Exceptional Items
As the name suggests, these are one-off events that either caused a great expense or a big bout of revenue. For example, suppose a company sold off some of its machinery because it did not use it anymore. This led to an income of Rs 1 crore – a big sum for a single transaction. This could easily boost the company’s profits in that particular quarter/year. However, this is not likely to recur again. So, it is counted as an ‘Exceptional Item’.
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Different from Extraordinary Items
Don’t confuse it, however, with ‘Extraordinary Items’. The key difference lies in whether or not the item is related to the company’s regular operations. Selling machinery (from the previous example) is a part of the company’s operations, although not one conducted every quarter or year. Extraordinary items, however, are not part of the regular operations. For example, a flood damaging company equipment or loss in production due to labour strike can be considered Extraordinary Items.
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Why do they matter
While they may be different, both Exceptional and Extraordinary Items are important. First, it can provide insight into the financial repercussions of certain events and company decisions. For example, Asian Paints reported a Rs 52.5-crore expense due to loss of goodwill related to a company acquisition in its recent result. This is vital information when calculating the profitability of its investment in the new company. Secondly, exceptional and extraordinary items are important while calculating the actual growth in the business.
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Use in company analysis
Exceptional items as well as Extraordinary Items are reported in the Profit and Loss statement. A detailed explanation regarding the nature of the item is given in the notes to accounts. It is in the best interest of the investor to look for recurring profit to make any judgement regarding the performance of the company. To do this, analysts usually adjust the Net Profit or Operating Profit for these items by subtracting the expense/income as well as its tax. The idea is that since these items do not recur on a regular basis so taking them out of the picture is likely to give a truer account of the business.
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Window dressing
It is also important that you look at Exceptional and Extraordinary Items. Companies have to give explanations for these Items in their financial reports. That said, it can also be manipulated to make the company’s balance sheet look better. This is called ‘Window Dressing’. So, do read the details of these Items and check for the explanations.
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1.6%
To get the real picture, it is important to adjust the net income and operating profits (EBITDA) for one-off exceptional and extra-ordinary items. This adjusted amount can be vastly different from the actual reported number. For the October-December 2015 quarter, a lot of companies announced exceptional items. Once adjusted for this amount, net income of the Sensex 30 companies grew 1.6% on a yearly basis. This is vastly different from the reported decline of 4.5% in net income.
