About this lesson
When calculating profitability, the different profit measures provide insight into the most significant factors that are creating corporate profit or loss.
There are several calculated values found on the Earnings Statement that refer to different aspects of corporate profitability.
When to Use Profit Measures
When calculating profitability, the different profit measures provide insight into the most significant factors that are creating corporate profit or loss. Use these different measures whenever analyzing the Earnings Statement.
- There are four profitability measures that are often used for analysing business profitability. Each of these can be found on the Earnings Statement.
- The profitability measures can be positive or negative. A positive value represents profit. A negative number represents loss.
- The most obvious is the final value of the Earnings Statement which is the Net Income. This is the profit or loss earned by the company during the time period represented by the Earnings Statement. This value is often used by the investing community.
- The operating profit, also known as operating margin or Earnings Before Interest and Taxes (EBIT), is the value of profit before any interest charges or incomes taxes are subtracted.
- This value is often used to measure the management capability of the general management team. The general manager is able to control everything above this line and but the items below the line are often out of his or her control. The interest charges were determined by the finance organization and capital markets and the taxes are set by the government taxing agency.
- The gross profit, also known as gross margin or contribution margin, is a measure of the sales and manufacturing effectiveness of the organization. It demonstrates the impact of selling one more item. The costs of sustaining and running the business are excluded.
- It is often used as an indicator of short term profitability if there is a market shift.
- EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, is a variation of the operating profit measure. In this case two of the items embedded in the operating expenses, depreciation and amortization, are also excluded from the calculation. These values are automatic calculations that must be included on the Earning Statement because of previous investment decisions.
- This profitability measure is often used with a new management team in companies that have a high level of capital investments. That is because the new management team has no ability to affect these values. Excluding them gives a better indication of the profitability of the current management team’s decisions.
- Each of these profitability measures provides insight into how the business is being managed.
Hints and Tips
- Make sure you know which measure is being referred to when discussing profitability. Each measure provides insight on business performance.
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