Basic earnings power

Basic earnings power
See also
Net income margin Bank efficiency ratio Capital gearing Combined Ratio Economic Value Added - EVA Return on sales Activity ratios Solvency ratios Operating cash flow ratio

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.

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

Formula of the basic earnings power

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

$BEP={\frac {EBIT}{Revenues}}\cdot {\frac {Revenues}{Total\ assets}}={\frac {EBIT}{Total\ assets}}$

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

"Example comapny" has EBIT (earnings before interest and taxes) in the amount of US$140,125 and total assets in the amount of US$700,625. 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 US$20 of operating profit from every US$100 invested in total assets. The result of this indicator can be compareed with results of industry competitors "to gauge the operational effectiveness of generating profits".

References

• Fabozzi F. J., (2016), Entrepreneurial Finance and Accounting for High-Tech Companies, MIT Press, London
• Leon S. M., (2015), Financial Intelligence for Supply Chain Managers: Understand the Link between Operations and Corporate Financial Performance, FT Press, Old Tappan
• Masoom K., (2013), The Entreprenaur’s Dictionary of Business and Financial Terms, Trafford Publishing, Singapore,
• Rist M. & Pizzica A. J., (2014), Financial Ratios for Executives: How to Assess Company Strength, Fix Problems, and Make Better Decisions, Springer, Berlin

Author: Wojciech Musiał