The EBIT margin formula can be used to determine the profitability of a firm under different market conditions.
The Earnings Before net Interest and Tax (EBIT) margins have always been very important for fundamental and technical analysts to determine the profitability of firms operating in different sectors of the economy. Their main use is to find out whether the company is efficient in its operations or not, which will determine its standing as a prime investment option. Before understanding its computation formulas, it is important to understand why you need to calculate the same.
Why to Calculate?
Efficiency in operations is a must for firms to prosper, whether they are producing goods in large or small quantities. However, the fact is that, the required operational efficiency is observed in only a few companies. There are many factors on which operational efficiency depends, and the most important one is the quality of company management. Separating the non-performing companies from the well-managed ones is possible by looking at EBIT margins. You can derive the kind of sales generated by the company on a quarterly, half-yearly, or yearly basis. The firms which are strong on operational basis, can alone generate free cash flows and rising net profits and hence, these margins are important.
If you wish to know how to value a stock, then considering solely these margins is not sufficient. Interest outgo on debt to banks and financial institutions is something, which every organization has to deal with, and neglecting it would not give an exact idea of how successful a business can be. Taxes also constitute an important part of the total expenses, and these margins do not consider them. Taking into account the net profits generated by firms becomes essential because of these associated problems. EBITDA calculation can also be useful in knowing the state of businesses correctly. A knowledge of EBITDA and information on its calculation will help you buy stocks of the right companies.
How to Calculate?
The details regarding the EBIT of companies can be obtained from disclosures given by the companies themselves, or from the media. If you wish to calculate it yourself, you need to add the net income, interest payouts, and the taxes paid. The second step is to find out the net revenue generated by the company in a particular time. Most likely, you will get this data from the annual report of the company, which reflects its performance in the whole year. The third and the last step is to divide this figure by the net revenue figure, and that will give you the EBIT margin.
These margins cannot be very high. There are some businesses which are quite capital-intensive, and the sale of products fluctuate as per market conditions. These figures would be high in the case of finance companies and information technology companies.