Basic earnings power

Basic earnings power
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Methods and techniques

Basic earnings power (BEP) is a measure that illustrates the power to generate profits that the company's assets have before tax and debt service. This ratio does not take into account tax conditions and various levels of financial leverage what allows to compare companies which otherwise would not be possible to compare[1].

Basic earnings power is used as a ratio measuring the effectiveness of operations, however, to fully analyze the issues related to asset management, BEP should be combined in conjunction with other turnover indicators[2]

Formula of the basic earnings power[edit]

Basic earnings power illustrates the ratio of earnings before interest and taxation to total asset of company and it is expressed by the formula[3]:

\(BEP = \frac{EBIT}{Revenues} \cdot \frac{Revenues}{Total\ assets} = \frac{EBIT}{Total\ assets}\)

Where:

  • BEP - basic earnings power
  • EBIT - earnings before deducting interest and taxes

Basic earnings power can be also expressed as quotient operating profit margin and total asset turnover:

\(BEP = Operating\ profit\ margin \cdot Total\ asset\ turnover\)

Where:

  • Operating profit margin is calculated from the formula:
\(Operating\ profit\ margin = \frac{Operating\ income}{Revenues}\)
  • and total asset turnover from the formula:
\(Total\ asset\ turnover = \frac{Revenues}{Average\ total\ assets}\)

Example and interpretation[edit]

"Example comapny" has EBIT (earnings before interest and taxes) in the amount of 140,125 USD and total assets in the amount of 700,625 USD. This gives a basic earnings power ratio (BEP) on the level of 0.20

\(BEP = \frac{EBIT}{Total\ assets} = \frac{140,125}{700,625} = 0.20\)

BEP can be also expressed as a percentage, then it is:

\(BEP = \frac{EBIT}{Total\ assets} \cdot 100\% = \frac{140,125}{700,625} \cdot 100\% = 20\%\)

This result tells us that company generated 20 USD of operating profit from every 100 USD invested in total assets. The result of this indicator can be compareed with results of industry competitiors "to gauge the operational effectiveness of generating profits"[4].

Footnotes[edit]

  1. Rist M. & Pizzica A.J., (2014), p. 17,
  2. Masoom K., (2013), p. 55,
  3. Fabozzi F. J., (2016), p. 228-236,
  4. Rist M. & Pizzica A.J., (2014), p. 17,

References[edit]

Author: Wojciech Musiał