Basic Earning Power (BEP)
The basic earning power (BEP) ratiois calculated by dividing earnings before inter-
est and taxes (EBIT) by total assets:This ratio shows the raw earning power of the firm’s assets, before the influence of
taxes and leverage, and it is useful for comparing firms with different tax situations and
different degrees of financial leverage. Because of its low turnover ratios and low
profit margin on sales, MicroDrive is not getting as high a return on its assets as is the
average company in its industry.^10Return on Total Assets
The ratio of net income to total assets measures the return on total assets (ROA)af-
ter interest and taxes:MicroDrive’s 5.7 percent return is well below the 9 percent average for the industry.
This low return results from (1) the company’s low basic earning power plus (2) high
interest costs resulting from its above-average use of debt, both of which cause its net
income to be relatively low.Return on Common Equity
Ultimately, the most important, or “bottom line,” accounting ratio is the ratio of
net income to common equity, which measures the return on common equity
(ROE):Industry average15.0%.$113.5
$89612.7%.Return on
common equity
ROENet income available to
common stockholders
Common equityIndustry average9.0%.$113.5
$2,0005.7%.Return on
total assets
ROANet income available to
common stockholders
Total assetsIndustry average17.2%.$283.8
$2,00014.2%.Basic earning power ratio (BEP)EBIT
Total assetsProfitability Ratios 385(^10) Notice that EBIT is earned throughout the year, whereas the total assets figure is an end-of-the-year
number. Therefore, it would be conceptually better to calculate this ratio as EBIT/Average assets
EBIT/[(Beginning assets Ending assets)/2]. We have not made this adjustment because the published
ratios used for comparative purposes do not include it. However, when we construct our own comparative
ratios, we do make the adjustment. Incidentally, the same adjustment would also be appropriate for the next
two ratios, ROA and ROE.