In this article, we will be discussing Other Income and Exceptional items of the business, what is it and why Investors should be careful of high other income and exceptional items. So, let’s get started!What is Other Income:
- Other income constitutes all the income earned by the company from operations that are not related to the main operation of the company.
- Following is a non-exhaustive list of examples of constituents of other income:
o Interest income on bank deposits
o Dividend income from investments
o Foreign exchange gain
o Fair value gain on investments
o Provisions are written back
o Miscellaneous income
What are exceptional items and what does it constitute?
- Other Income is visible in the Profit & Loss Statement of the company below the revenue from operations which refers to income from the core business of the company.
- Description of the Other Income is classified in the notes of accounts.
- Exceptional items can be defined as those items that are clearly distinct from the ordinary course of the company’s business but have a material effect on the profitability of the company.
- Certain examples of exceptional items are as under –
o Impairment loss on fixed assets
o Write down inventories
o Disposal of long-term investments
o Settlement of a litigation
Why be careful of these items?
- For Exceptional items also, the company provides notes to accounts and hence one should carefully watch this item as this can cause some abnormality in the financial figures of the company.
Some Examples:Zydus Lifesciences (earlier Cadila Healthcare):
- While analyzing the company’s performance in the period, these items should be excluded to arrive at the sustainable earnings that the company has for the period.
- Most material items in “Other income” and “exceptional items” are one-off events. If these are not excluded, they can distort the analysis and provide an incorrect picture.
- High other income might not necessarily be a red flag but sometimes, companies may purposely report high other income in periods when their key area of operation is not doing well to report a healthy profit after tax.
- Investors need to check if the material items under these heads are appearing frequently in the financial statements – This could be a major red flag.
- In their numbers for Mar-22, the company reported a gain on disposal of discontinued operations to the tune of Rs. 2,681 Cr. A negative amount of exceptional items shows that this was income of the company
- This was a significant amount considering it formed 58% of the net profit of the company
- This gain was due to the disposal of a subsidiary that the company made during the year If we compare Zydus Lifesciences with its peers, it might seem that the company is severely undervalued. The calculation of the PE Ratio takes the net profit of the company into account which includes the effect of exceptional items. However, we get a clearer picture when we remove the effect of exceptional items.
What Should Investors Do?
- After excluding the effect of exceptional items, the adjusted PE Ratio of the company goes up to 23.30 which gets it closer to its peers and the company does not seem as undervalued as it did earlier after the adjustment
The amount of Other Income and exceptional items are important to figure out what an investor should look for. These figures are not stable and generally have one time impact on the company. Also, the rising other income is an alarming situation as this shows the company is deviating from its core business. Hence, an investor should carefully assess such numbers from financial statements before making any investment decision.
Disclaimer: The information here is provided for reference purposes only and should not be misconstrued as investment advice. Under no circumstances does this information represent are commendation to buy or sell stocks or MF.
Originally Pubished On:https://blog.investyadnya.in/what-is-other-income-in-businesses-why-investors-should-be-careful-of-companys-high-other-income-and-exceptional-items/