What is Basic Earnings Power Ratio?
The Basic Earnings Power Ratio determines the efficiency at which a company utilizes its assets to produce operating income (EBIT).
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How to Calculate Basic Earnings Power Ratio (Step-by-Step)
The basic earnings power ratio is a profitability metric that measures how efficiently a company is allocating its resources (i.e. asset base) to generate operating income.
The basic earnings power ratio compares a company’s operating income (EBIT) to the value of its total assets.
- Operating Income: Operating income, or “EBIT”, is the remaining revenue after deducting operating costs, i.e. cost of goods sold (COGS) and operating expenses (SG&A, R&D).
- Total Assets: The total assets of a company are the sum of the value of its current assets (e.g. cash, accounts receivables, inventory) and non-current assets (e.g. PP&E).
The operating income of a company can be found on the income statement, while the value of its total assets is recorded on the balance sheet.
The basic earnings power ratio is one method to understand a company’s earnings capability prior to non-operating items (e.g. interest income, interest expense) and taxes.
Since operating income (EBIT) is the profit metric in the numerator—unlike in the return on assets (ROA) metric—the pre-financial leverage and pre-tax aspect of the basic earnings power ratio makes it more useful for comparisons among industry peers.
- Higher BEP Ratio: The company is more efficient at utilizing its assets to produce income.
- Lower BEP Ratio: The company is less efficient at utilizing its assets to generate income.
Basic Earnings Power Ratio Formula (BEP)
The formula for calculating the basic earnings power ratio is as follows.
Where:
- Operating Income (EBIT) = Gross Profit – Operating Expenses
- Total Assets = Current Assets + Non-Current Assets
Note: The denominator of the ratio, total assets, can be adjusted to include only a company’s operating assets, as well as to remove intangible assets like goodwill. The important rule to follow is to apply the same adjustments to the entire peer group to remain consistent in the calculation.
Basic Earnings Power Ratio — Excel Model Template
We’ll now move on to a modeling exercise, which you can access by filling out the form below.
Basic Earnings Power Ratio Calculation Example
Suppose you’re tasked with calculating the basic earnings power ratio of a company given the following assumptions.
- Revenue = $50 million
- COGS = ($20 million)
- SG&A = ($10 million)
- R&D = ($10 million)
- Current Assets = $40 million
- Non-Current Assets = $85 million
The gross profit of the company is $30 million, which after subtracting its operating expenses (i.e. SG&A and R&D), results in an operating income (EBIT) of $15 million.
- Gross Profit = $50 million – $20 million = $30 million
- Operating Income (EBIT) = $30 million – $10 million – $5 million = $15 million
Next, the total assets of our company equal $125 million, which is simply the sum of its current and non-current assets.
- Total Assets = $40 million + $85 million = $125 million
In conclusion, we’ll calculate our company’s basic earnings power ratio by dividing its operating income (EBIT) by its total assets, which comes out to 12.0%.
- Basic Earnings Power Ratio (%) = $15 million ÷ $125 million = 12.0%
