Profitability of UK companies: October to December 2015

The net rate of return on capital employed for UK private non-financial corporations related to their UK operations.

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This is an accredited national statistic.

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Release date:
6 April 2016

Next release:
5 August 2016

1. Main points

The profitability of private non-financial corporations (PNFCs), as measured by their net rate of return, was estimated at 13.0% in Quarter 4 2015, unchanged from Quarter 3 2015.

Manufacturing companies’ net rate of return was estimated at 7.2% in Quarter 4 2015, 0.9 percentage points higher than the revised estimate of 6.3% in Quarter 3 2015.

Service companies’ net rate of return was estimated at 22.0% in Quarter 4 2015. This was 1.2 percentage points lower than the revised estimate of 23.2% in Quarter 3 2015.

UK Continental Shelf (UKCS) companies’ net rate of return was 0.6% in Quarter 4 2015. This is the lowest recorded quarterly estimate since the series began in 1997 and is 1.3 percentage points lower than the revised estimate of 1.9% in the previous quarter. This reflects falling oil and gas prices, which failed to be offset by increased quarter-on-quarter sales.

To see the above data in more context, data for earlier periods are shown in Tables 1 and 2, and are also presented in Figures 1 to 6.

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2. Understanding profitability

Profitability, and specifically the net rate of return, is a common way of measuring the economic success of a company or sector. The rate of return is calculated by expressing the economic gain, or profit, as a percentage of the capital used to produce it. In this case, “net” means the rate of return net of capital consumed, rather than net of taxes on company income. See section 2 of the background notes for a more comprehensive definition.

Revisions to the net rates of return for PNFCs have been made back to Quarter 1 2015, and are consistent with the Quarterly National Accounts Quarter 4 (Oct to Dec) 2015 published on 31 March 2016.

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3. Your views matter

We are constantly aiming to improve this release and its associated commentary. We would welcome any feedback you might have, and would be particularly interested in knowing how you make use of these data to inform your work. Please contact us via email: profitability@ons.gov.uk or telephone Eric Crane on +44 (0)1633 455092.

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4. Net rate of return of private non-financial corporations

The net rate of return of all private non-financial corporations (PNFCs) in Quarter 4 2015 was estimated at 13.0%, unchanged from the revised estimate for Quarter 3 2015.

The net rate of return of PNFCs for 2015 as a whole was 12.9%. This was 0.1 percentage points higher than 2014 and the highest rate of return since 1998. As the following sections will demonstrate, this slight overall increase is made up of larger movements in different industrial groups.

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5. Economic context

The net rate of return of UK companies – which is the ratio of operating surplus to capital employed – remained stable at 13.0% between Quarter 3 and Quarter 4 2015. This coincided with an increase in UK GDP in volume terms of 0.6% between Quarter 3 2015 and Quarter 4 2015.

While the aggregate net rate of return remained the same on a quarterly basis, there were disparities between industries. The net rate of return for the manufacturing industries increased from 6.3% in Quarter 3 2015 – its lowest level for 2 years – to 7.2% in Quarter 4 2015. This was driven by an increase in operating surplus and a decline in capital employed, as firms made larger profits from a slightly reduced capital base. This coincided with an increase in the volume of output in the manufacturing industry of 0.1% between Quarter 3 and Quarter 4 2015.

In contrast, the net rate of return in the service industries fell from 23.2% in Quarter 3 2015 – the highest rate since comparable records began in 1997 – to 22.0% in Quarter 4 2015. This was driven by a fall in operating surplus and an increase in net capital employed, as services firms expanded their use of capital and experienced a fall in the level of profits. This occurred despite an increase in nominal output growth in the services industry (in current prices) to 1.4% between Quarter 3 and Quarter 4 2015. This suggests that the labour share of income grew in these industries in Quarter 4 2015.

The net rate of return for UK Continental Shelf companies – which are mainly involved with the extraction of oil and gas from the North Sea – declined from 1.9% in Quarter 3 2015 to 0.6% in Quarter 4 2015. The profits of these industries are likely to have been affected by the fall in the oil price over the last year: the Brent crude benchmark fell from $77.06 a barrel in Quarter 4 2014 to $44.77 a barrel in Quarter 4 2015. However, the fall in oil prices was also cited to have affected other industries linked to the oil extraction industry. According to Ernst & Young half of FTSE companies involved with Oil Equipment, Services & Distribution (at a different stage of the supply chain) issued a profit warning in 2015. This coincided with a decline in the output of companies involved in the extraction of crude petroleum and natural gas by 2.3% between Quarter 3 and Quarter 4 2015.

The slight decline in services profitability is reflected by several external indicators. Ernst & Young reported that UK quoted companies issued 100 profit warnings in Quarter 4 2015, the highest number since the first quarter of 2009. In Quarter 4 2015 the FTSE sectors with the most profit warnings were Support Services (16), General Retailers (7), Media (6) and Travel & Leisure (6). However, there were also some signs of weaker profitability outside the services industries. For example, in 2015 overall, 42% of FTSE Electronic & Electrical Equipment and 40% of FTSE

Aerospace & Defence companies issued profit warnings. The fall in both oil and other general commodity prices could have been a factor behind this: Ernst & Young attributed a fifth of profit warnings across the whole economy in 2015 to falling commodity prices. Firms’ investment behaviour may also have been affected by these changeable conditions: business investment in volume terms fell by 2.0% to £43.3 billion between Quarter 3 and Quarter 4 2015.

According to the Confederation of British Industry (CBI) Service Sector Survey, growth in business volumes increased more strongly than expected in Quarter 4 2015, while profitability improved at a healthy pace.

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6. Manufacturing and service companies

Manufacturing companies

The estimated net rate of return for manufacturing companies in Quarter 4 2015 was 7.2%. This was 0.9 percentage points higher than the revised estimate for Quarter 3 2015 (6.3%). Profitability for manufacturing companies in 2015 as a whole was 8.3%, down from 11.7% in 2014.

Service companies

The estimated net rate of return for service companies in Quarter 4 2015 was 22.0%. This was lower than the Quarter 3 rate of 23.2%, but still the second-highest estimated rate since the series began in 1997. As with manufacturing, revisions to net rates of return throughout 2015 reflect late survey returns. The net rate of return of service companies in 2015 as a whole was 21.6%, the highest annual rate since the series began.

Figure 2 shows the net rate of return for manufacturing and service companies since Quarter 4 2007. Manufacturing profitability, after hitting a low in 2009, climbed gradually from 2010 to 2012 and then more rapidly in 2013 and early 2014, before falling in most of the last few quarters. However, service companies’ profitability has been on a generally upward trend over the same period.

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7. UK non-Continental Shelf (UK non-CS) companies

UK non-CS companies comprise manufacturing, service and other UK non-CS companies (such as construction and power supply).

The estimated net rate of return for UK non-CS companies in Quarter 4 2015 was 13.5%, which is 0.1 percentage points higher than the revised estimate of 13.4% for Quarter 3 2015. This is the highest quarterly estimated rate since Quarter 4 1998 (13.6%).

As the net rate of return of UK non-CS companies makes up the majority of private non-financial corporations (PNFCs), Figure 3 shows a comparable picture to that of all PNFCs (Figure 1).

The annual net rate of return in 2015 for UK companies excluding continental shelf companies, was 13.2%. This is 0.5 percentage points higher than in 2014 and the highest annual rate since 1998. This increase is greater than for UK PNFCs as a whole, as it excludes the fall in profitability in UK continental shelf companies, discussed in the following section.

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8. UK Continental Shelf (UKCS) companies

UKCS companies are defined as those involved in the exploration for, and extraction of, oil and natural gas from the UK Continental Shelf, the area beyond the UK’s territorial sea over which the UK claims mineral rights. Due to the nature of the capital assets employed, net rates of return for continental shelf companies are not directly comparable with those for other industries.

The estimated rate of return for UKCS companies in Quarter 4 2015 was 0.6%. This was down 1.3 percentage points from the revised estimate of 1.9% in Quarter 3 2015. This is the lowest quarterly figure since the series began in 1997 and reflects falling oil and gas prices, which failed to be offset by increased quarter-on-quarter sales.

The annual net rate of return of UKCS companies in 2015 was 3.5%, also the lowest since the series began in 1997.

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9. International comparisons

Profitability is a relative measure of profit and what created it. This bulletin shows the rate of return on capital employed. Unfortunately, other countries use a range of different measures, making international comparisons difficult.

It is possible to compare the aggregated national profit share, defined as Gross Operating Surplus (GOS) plus Mixed Income (income made by the self-employed and other non-incorporated businesses) divided by Gross Value Added (GVA) on a European System of Accounts 2010 (ESA10) basis. GVA is the difference between the cost of inputs (whether capital or labour) and the cost of the output. The difference in the cost is due to the value added by the use of labour and capital. GOS is the income earned from capital. The national profit share measure includes the activity of other profit-making sectors, such as financial corporations and public corporations, while the rest of this bulletin refers to the activities of private non-financial corporations only.

International data on an ESA10 basis are only available at the aggregate national level, shown for selected countries below (Figure 5). 2015 values for the UK, Germany and Spain have been added since the previous publication, to make use of updated source data.

The addition of 2015 data shows that the UK profit share (44%) remains comparable with that of Germany (44%), but continues to be lower than that of Spain (47%).

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10 .Background notes

  1. What's new

    Revisions

    Revisions to rates of return have been incorporated in this release from Quarter 1 2015 to ensure consistency with the Quarterly National Accounts Quarter 4 (Oct to Dec) 2015. The revisions to the time series are presented in Table R1 accompanying this bulletin.

  2. Understanding the data

    Interpreting the data

    The rates of return presented are ratios of operating surpluses compared to capital employed, expressed as percentages. The ratios measure the "accounting" rates of return achieved in a particular period against total capital employed. The rates of return are on the basis of current replacement cost and relate to UK operations of private non-financial corporations (PNFCs). The net rate of return uses capital estimates that are net of capital consumption, and is more widely used than the gross rate of return. Rates of return are published for quarters and for years.

    The main sources of operating surpluses data used in the compilation of the rates of return are the Quarterly Operating Profits Survey (QOPS) and company profits data provided by HM Revenue and Customs (HMRC).

    The underlying capital data used to calculate these rates of return are based upon capital stocks and capital consumption data.

    Definitions and explanations

    Private non-financial corporations (PNFCs) are comprised of UK Continental Shelf (UKCS), manufacturing, non-financial service sector companies and others (including construction, electricity and gas supply, agriculture, mining and quarrying). UKCS companies are defined as those involved in the exploration for, and extraction of, oil and natural gas in the UK.

    The gross operating surplus of PNFCs consists of gross trading profits, plus income from rental of buildings, less inventory holding gains.

    Gross trading profits include only that part of a company's income arising from trading activities in the UK. It does not include income from investments or other means, such as earnings from abroad. Gross trading profits are calculated before payments of dividends, interest and tax. The gross trading profits figures used in the calculation of gross operating surplus exclude the quarterly alignment adjustments applied to UK non-CS companies’ gross trading profits, as published in the Quarterly National Accounts.

    Inventory holding gains are the changes in the value of inventories due only to price. Book values are deflated to constant prices, and the constant price book value change (the difference between the value at the end of the period and the beginning) is estimated. This book value change is then reflated to give estimates of changes in inventories in current prices. This removes the effect of price changes between the two periods, which are the holding gains.

    Capital stock represents the value of all fixed assets used in production in the economy that are still in use, such as machinery, dwellings and intellectual property products such as software. Capital employed is the average value of fixed assets, during the period, plus the value of inventories. This includes all tangible assets and intellectual property products which have been produced and are themselves repeatedly or continuously used in the processes of production for more than a year. Tangible assets include buildings, plant and machinery. Intellectual property products include computer software and mineral exploration costs. For UKCS companies, capital employed includes mineral exploration costs and oil rigs, but not the oil and gas reserves that are classified as non-produced assets. Inventories include raw material and fuel that are used up in production. Book values are used for levels of inventories.

    Gross capital stock shows how much the economy’s assets would cost to buy again as new, or their replacement cost. Estimates of net capital stock are net of accumulated consumption of fixed capital; that is, they are a measure of the written down replacement costs of fixed assets. A way of thinking about this is to consider a car owned by a household, which was bought as new. A reasonable estimate of gross capital stock would be the cost of replacing the car with a new one; net capital stock would be the value of the car at the current time (with wear and tear).

    In the calculations for net rates of return, estimates of net operating surplus are net of the consumption of fixed capital (depreciation). The consumption of fixed capital is derived from capital stock and covers the depreciation of fixed assets over their service lives.

    Use of the data

    The underlying profits data used to calculate the rates of return are used within the UK National Accounts. They are consistent with the Quarterly National Accounts Quarter 4 (Oct to Dec) 2015, published on 31 March 2016.

  3. Methods

    Sampling methodology

    Details on the methods used for the Quarterly Operating Profits survey are available in the Quality Methodology Information document.

    Perpetual inventory method

    Underlying estimates of capital stock and capital consumption are produced using the perpetual inventory method. Further details are available in the Capital Stock, Capital Consumption, Methodological changes to the estimation of capital stocks and consumption of fixed capital publication, which was published on 25 June 2014.

  4. Quality

    The net rate of return is defined as the ratio of the operating surplus compared with the capital employed, expressed as a percentage. The accuracy of the data in the numerator is likely to be high because the main component (profits) also draws upon definitive, comprehensive, HMRC data. The Quality and Methodology Information report for Profitability is available on our website.

    Revisions

    Table R1 accompanying this bulletin shows the revisions to the net rates of return made back to Quarter 1 2014. These revisions are consistent with the data published in the Quarterly National Accounts Quarter 4 (Oct to Dec) 2015 published on 31 March 2016.

    Estimates for the most recent quarters are provisional and, as usual, are subject to revisions in the light of updated source information consistent with the National Accounts revisions policy. We have a web page dedicated to revisions to economic statistics which brings together our work on revisions analysis, links to relevant articles, revisions policies and key documentation.

    Further detailed information on all changes to National Accounts can be found here:

    National Accounts changes: impact on real GDP 1997-2011
    National Accounts articles: The UK Flow of Funds Project: Improvements to the Sector and Financial Accounts
    United Kingdom National Accounts, the Blue Book, 2015 Edition
    Capital Stock, Capital Consumption, Impact of the methodological changes to the estimation of capital stocks and consumption of fixed capital

  5. Relevant links

    Quarterly National Accounts
    United Kingdom Economic Accounts

  6. Publication policy and Code of Practice for Official Statistics

    Details of the policy governing the release of new data are available from the Media Relations Office. Also available is a list of those given pre-publication access to the contents of this release.

    National Statistics are produced to high professional standards set out in the Code of Practice for Official Statistics. They undergo regular quality assurance reviews to ensure that they meet customer needs. They are produced free from any political interference.

  7. Accessing data

    The complete run of data in the tables of this statistical bulletin is available to view and download in electronic format through our time series data. Users can download the complete bulletin in a choice of zipped formats, or view and download their own sections of individual series.

  8. Reproduction

    You may use or re-use this information (not including logos) free of charge in any format or medium, under the terms of the Open Government Licence. To view this licence go to The National Archives or write to: The Information Policy Team, The National Archives, Kew, London TW9 4DU

    Email: psi@nationalarchives.gsi.gov.uk

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Contact details for this Statistical bulletin

Eric Crane
profitability@ons.gov.uk
Telephone: +44 (0) 1633 455092