Basic Earning Power Ratio
It is a metric that reflects the relation of earnings of the company to its assets. And it shows the company’s efficiency in generating earnings from its assets. Hence, the basic earning power ratio calculator helps in checking this efficiency.
The higher the Earning Power Ratio, the better it is.
Formula
The formula for calculating the basic earning power ratio is:
Basic Earning Power Ratio = EBIT / Total Assets
Or,
Basic Earning Power Ratio = Operating Profit Margin * Total Assets Turnover Ratio.
We need to understand that the second formula will eventually give the same result as the first one. How? Let us have a look.
Operating Profit Margin = EBIT / Turnover
Total Assets Turnover Ratio = Turnover / Total Assets
Now putting both these formulas in the second formula of the basic earning power ratio, we will get the first formula.
Basic Earning Power Ratio = (EBIT / Turnover) * (Turnover / Total Assets)
That is, EBIT / Total Assets
About the Calculator
Basic Earning Power Ratio Calculator effortlessly provides the result by simply providing it with the following details:
- EBIT (Earnings Before Interest and Tax)
- Total Assets
Calculator
How to Calculate using Calculator?
The user has to only type the following figures in the calculator and will get the result with a simple click on the calculate button.
EBIT
It is the earnings of the company before paying off interest and taxes. Both operating and non-operating incomes are a part of this. EBIT can be calculated with the help of the following formula:
EBIT = Net Income + Interest + Taxes
To know more about EBIT, refer to the article: EBIT
Total Assets
We can easily obtain the value of total assets from the balance sheet.
Example
Suppose Mr. X, having a surplus of $65,000, wishes to make an investment. He is interested in investing in a project of his known one. The estimated net income of the project is $275,000, interest is $35,000, and tax is equal to $90,000. The total assets stand at $3,500,000.
Also Read: Basic Earning Power Ratio
EBIT = 275,000 + 35,000 + 90,000 = 400,000
Basic Earning Power Ratio = (400,000 / 3,500,000) * 100 = 11.43%
Interpretation
As said above, the higher the basic earning power ratio, the better it is. It simply shows the company’s efficiency in using its assets. The basic earning power ratio in the above example is relatively good. But this cannot be stated true without comparison with a similar project or similar industry.
Cautions
Basic earning power shows the efficiency in the performance of assets of the company. But what next? It does not provide a clear picture that helps in arriving at a decision. It needs further evaluation using other ratios and comparison tools. The basic earning power ratio is an indicative factor and not conclusive. And as usual, this should not be used in isolation.
