Had you paid close attention to results over the past few weeks, you would have caught more than a passing mention of ‘other income' boosting earnings. ‘Other Income' appears in the Profit & Loss account after revenues. But why is it significant?
Quality of earnings
For any stakeholder in a company, what matters as much as the company's earnings are the quality and sources of these earnings. A higher proportion of income from core operations always lends greater credence to the quality. A higher ‘other income' component can camouflage the real performance of the company by either boosting profits or minimising losses.
Consider the results of Maruti Suzuki for the June '11 quarter. Its net profits grew 18 per cent over the June ‘10 quarter. This performance has come despite net sales growth of only 3.3 per cent. It was an 80 per cent growth in other income that aided profit growth. Similarly, the FY-11 (reported) consolidated net profit growth of Trent was 79 per cent, against a 42 per cent expansion in revenues and a near-equal rise in almost every cost head, . Here, ‘other income' grew 48 per cent.
Operational vs. Financial income
With the case for taking note of ‘other income' now established, Let's proceed with understanding the income from various sources that is reported under the ‘other income' head. Broadly, other income may either be financial or operational.
Dividend received from investments, interest received from banks, interest on receivables and on advances to vendors are good examples of ‘financial other income'. Income from scrap sales, rentals from the leasing of assets by companies in the engineering/capital goods space are typical of ‘other income' arising from operations. For small companies, these items could be a significant source of income.
Hence, the next time you calculate operating profits/ margins for a company, remember not to leave out the ‘other income' completely. That portion of ‘other income' that is attributed to operations must be added with net sales before deducting the expenses. At the same time, take care to not include items such as income from joint ventures when calculating operating margins. These items, though arising from operations, are better off being added at the net profit level. The best place to get the break-up of ‘other income' is in schedules to the profit and loss account in annual reports.
While ‘other income' from operations may be sustainable, there are one-off items such as exchange gain on forex transactions and income from sale of investments which may boost ‘other income' during a particular quarter. Such as spike is purely temporary and not sustainable.
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