The Australian Small Business Blog

Friday, March 22, 2013

Small Business Best Practice Benchmarks - EBIT

by Dr Greg Chapman

Previous small business best practice benchmarks articles were focused on planning and management. Next we turn to financial performance, specifically Earnings Before Interest and Tax (EBIT). This an important measure for any business, but first we need to understand what it is measuring.

Good benchmarks try to exclude factors that are not relevant to what is being measured so that comparisons can be made on an apples to apples basis. By taking out the Interest component, comparisons between different businesses irrespective of their financing arrangements are possible, thus focusing on their underlying profitability.

Tax is also taken out of this measure to keep the focus on underlying operational performance which may be distorted by different ownership structures and deductions claimed.

EBIT, however, does include Depreciation, so a profit return on Capital Assets is a part of this measure. This is important because investments might have been made to improve productivity or assets may have been purchased rather than leased. Both these actions have the effect of reducing expenses, but by including depreciation, the effect of these decisions is relatively neutral when using this measure.

The EBIT benchmark is usually made as a ratio to Sales in order to standardise the result over a range of different business sizes. The Best Practice Small Business Benchmark for EBIT is > 12% of Sales. The problem with a lower target is that small changes in Sales can easily turn a modest profit into a loss. While it is possible to run businesses with single digit EBIT ratios, such businesses are usually low margin, high volume businesses with very strong financial controls, not typically seen in the small business sector.

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Dr Greg Chapman is the Director of Empower Business Solutions and The Australian Business Coaching Club and is Australia's Leading Advisor on Emerging Businesses and provides Coaching and Consulting advice to Australian Small Business Owners in Marketing & Business Strategies Planning & Systems. He is also the author of The Five Pillars of Guaranteed Business Success and Price: How You Can Charge More Without Losing Sales.

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