Profitability of UK companies: October to December 2016

• Private non-financial corporations (PNFCs) reported an improved net rate of return of 12.4% for Quarter 4 (Oct to Dec) 2016, compared with 12.1% in Quarter 3 (July to Sept) 2016.

• The net rate of return for companies in the UK continental shelf (UKCS) sector increased to 3.9% in Quarter 4 2016 from 2.4% in Quarter 3.

• Profitability of manufacturing companies increased from 11.8% in Quarter 3 to 12.7% in Quarter 4 2016.

• In contrast, service companies’ profitability declined from 18.3% in Quarter 3 to 17.7% in Quarter 4 2016.

This bulletin provides estimates of the profitability of UK-based private non-financial corporations (PNFCs). PNFCs comprise UK continental shelf (UKCS) companies and other non-financial UK (non-UKCS) companies. Non-UKCS companies are split by broad industry: manufacturing companies, non-financial services industry companies and others (such as construction, electricity and gas supply, agriculture, mining and quarrying).

UKCS companies engage in oil and natural gas exploration or extraction. This only includes companies operating on the UK continental shelf – the area where the UK claims mineral rights beyond the territorial sea. Owing to the nature of the industry, UKCS companies tend to be very capital-intensive, meaning they require high levels of capital investment to operate. They also report high levels of depreciation of their fixed assets. For these reasons, the net rate of return for UKCS companies is not directly comparable with those for other sectors.

How do we measure profitability?

Net rate of return is used as the measurement of company profitability throughout this bulletin. The rate of return is calculated as the economic gain (profit) shown as a percentage of the capital used in production. “Net” means the rate of return excluding capital consumed and accounting for capital stocks at their current value. Capital consumed refers to the decline in the current value in the stock of fixed assets (for example, due to depreciation). Gross rates of return are available in the annex tables of this release.

Revisions to the data

Revisions to rates of return have been incorporated from Quarter 1 (Jan to Mar) 2016. This is to ensure consistency with the Quarterly National Accounts for Quarter 4 (Oct to Dec) 2016, published on 31 March 2017. Revisions to the time series are presented in Table R1 accompanying this bulletin, which is available for download from our website.

Estimates for the most recent quarters are subject to revisions through updated source information. For more information, please refer to our web page dedicated to revisions to economic statistics, which brings together our work on revisions analysis, links to relevant documentation and revisions policies.

The net rate of return for the private non-financial corporations (PNFC) sector increased in Quarter 4 (Oct to Dec) 2016 by 0.3 percentage points to 12.4% from 12.1% in Quarter 3 (July to Sept). The annual net rate of return for PNFCs also increased from 12.1% in 2015 to 12.3% in 2016. This reflected a general trend of steady growth since the financial crisis in 2008, as shown in Figure 1.

This increase in profitability for UK companies generally coincided with the broader economic picture. GDP grew by 0.7% in Quarter 4 2016. Moreover, Ernst and Young reported that UK non-financial companies issued 73 profit warnings in Quarter 4, which was the lowest since 2013. Quarter 4 also brought the yearly total of profit warnings to 283 in 2016 – the lowest in 3 years. However, business investment growth – an important indicator of business confidence – fell by 0.9% over the same period.

UK continental shelf (UKCS) companies have historically experienced volatile profitability. The UKCS annual net rate of return reached its lowest point in 2016 (2.8%) since the series began in 1997, due to the fall in oil prices. However, the quarterly data showed signs of recovery in the sector towards the end of the year, driven mainly by rising prices. Figure 2 depicts the improved net rate of return to 3.9% in Quarter 4 (Oct to Dec) from 2.4% in Quarter 3 (July to Sept).

The profitability of UK manufacturing companies improved in Quarter 4 (Oct to Dec) 2016. Net rate of return increased to 12.7%, up 0.9 percentage points from 11.8% in Quarter 3 (July to Sept). This increase in profitability coincided with an increase in manufacturing output, which increased by 1.2% in Quarter 4 2016. According to the Bank of England Agent Summary Report, growth in manufacturing output may have resulted from increased production in export supply chains, customers switching from international to domestic suppliers following the depreciation of sterling and increased demand from consumer services industries.

In contrast, the net rate of return for services industries fell from 18.3% in Quarter 3 2016 to 17.7% in Quarter 4 2016. One reason for this was perhaps the large volume growth in total costs per person, according to the Confederation of British Industry (CBI).

Whilst profitability in the services industries fell in the quarter, the services industries continued to expand. Services industries were the main driver in gross domestic product (GDP) growth, contributing 0.6 percentage points in Quarter 4 2016. The expansion in services industries was mainly due to the distribution, hotels and restaurants industry grouping, where output increased by 2% between Quarter 3 and Quarter 4 of 2016.

The gross operating surplus (GOS) of private non-financial corporations (PNFCs) is a component of the income approach to measuring gross domestic product (GDP). GOS consists of gross trading profits, plus income from rental of buildings, less inventory holding gains (changes in inventory value caused by price). See the Quarterly National Accounts for a detailed breakdown of the components of GDP.

The UK Economic Accounts detail estimates of national production, income and expenditure, UK Sector Accounts and the UK Balance of Payments.

We have updated the style of our bulletin this quarter to be more concise and user-friendly. We welcome any feedback and are particularly interested in knowing how you use the data to inform your work. Contact us via email at profitability@ons.gov.uk or telephone Eric Crane on +44 (0)1633 455092.

The “Profitability of UK companies” statistical bulletin reports the estimates for net rate of return on capital employed for UK private non-financial corporations (PNFCs) related to their UK operations.

The Profitability of UK companies and Quarterly Operating Profits Survey Quality and Methodology Information documents contain important information on:

• the strengths and limitations of the data and how it compares with related data

• uses and users of the data

• how the output was created

• the quality of the output including the accuracy of the data

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, published on 5 August 2016.