How to calculate EBIT margin for your small business

What is the EBIT margin?

EBIT stands for Earnings Before Interest and Taxes. It's a financial metric that measures a company's profitability by focusing solely on its core operations, excluding the effects of financing and taxation. The EBIT margin is expressed as a percentage and shows how much of a business's revenue is converted into operating profit.

In simpler terms, the EBIT margin clearly shows how efficiently your business is generating profit from its day-to-day operations. This is particularly useful for small businesses in Australia that want to evaluate their operational performance without the noise of external factors like loan repayments or tax obligations.

For example, if you run a small retail store, your EBIT margin will reveal how well you manage your costs, such as inventory and staff wages, relative to your revenue.

‍

How do you calculate the EBIT margin?

Calculating the EBIT margin is a simple but powerful exercise. The formula is:

EBIT Margin = (EBIT / Revenue) × 100

Let's break it down step-by-step:

1. Calculate EBIT (Earnings Before Interest and Taxes): To calculate EBIT, subtract your operating expenses from your total revenue. Operating expenses include rent, wages, utilities, and other day-to-day costs required to keep your business running. Make sure not to include interest payments or tax expenses in this calculation.
2. Example: Suppose your small business generates $500,000 in annual revenue and incurs $350,000 in operating expenses. Your EBIT would be: $500,000 - $350,000 = $150,000.‍
3. Divide EBIT by Total Revenue: Divide your EBIT by your total revenue. Using the example above, divide $150,000 by $500,000: $150,000 / $500,000 = 0.3.‍
4. Convert the Result into a Percentage: Multiply the Result by 100 to express it as a percentage: 0.3 × 100 = 30%.

In this example, your EBIT margin is 30%, which means that for every dollar of revenue your business earns, 30 cents is retained as operating profit.

What is a good EBIT margin?

The definition of a "good" EBIT margin varies widely depending on the industry. Different industries have different cost structures, which impact their profitability. Here are some general benchmarks:

• Service-based businesses typically have higher EBIT margins, often above 20%, because they usually have lower overhead costs than product-based businesses.
• Retail or product-based businesses often have lower EBIT margins, usually between 5% and 15%, due to higher costs associated with inventory and production.

An EBIT margin above 10% for Australian small businesses is generally considered healthy. However, comparing your EBIT margin to industry standards and competitors is essential for a more accurate sense of your performance.

‍

Why is it essential to track EBIT margin?

Your EBIT margin is more than just a number; it's a window into the financial health of your business. Here are several reasons why tracking it is vital:

1. Measures profitability: The EBIT margin highlights how much profit your business generates from its core operations. It directly measures your business’s ability to turn revenue into profit.
2. Identifies inefficiencies: A declining EBIT margin can indicate rising costs or falling revenue. By tracking this metric, you can promptly identify and address operational inefficiencies.
3. Supports strategic decision-making: Understanding your EBIT margin helps you make informed decisions about pricing, cost management, and investment opportunities. For instance, if your EBIT margin is low, you may need to evaluate whether to increase prices or find more cost-effective suppliers.
4. Improves financial planning: EBIT margin trends can help you set realistic financial goals and forecasts, enabling better planning for growth and expansion.
5. Enhances investor confidence: Investors and lenders often use the EBIT margin to assess a business's operational efficiency. A substantial EBIT margin can improve your chances of securing funding or investment.

What happens if you have a poor EBIT margin?

A poor EBIT margin can signal trouble and may indicate one or more of the following issues:

• High operating costs: Rising rent, wages, or raw materials costs could be eroding your profits.
• Inefficient processes: Operational inefficiencies, such as overstaffing or underutilised resources, can drag down your EBIT margin.
• Uncompetitive pricing: Selling products or services at a price that's too low can lead to a poor EBIT margin.
• Declining revenue: A drop in sales due to increased competition or changing market conditions can negatively affect your EBIT margin.

If your EBIT margin is consistently poor, corrective action is essential. Start by conducting a detailed review of your expenses and revenue streams. Identify areas where you can cut costs or improve efficiency, such as renegotiating supplier contracts, streamlining operations, or adjusting pricing strategies.

‍

What are other metrics that you should track?

While the EBIT margin is a key indicator of financial health, it's not the only metric that matters. Here are other essential metrics you should monitor:

1. Gross Profit Margin: This measures the profitability of your products or services by calculating the percentage of revenue left after covering the cost of goods sold (COGS).
2. Formula: Gross Profit Margin = [(Revenue - COGS) / Revenue] × 100.
3. Net Profit Margin: Unlike EBIT margin, this metric accounts for all expenses, including interest and taxes, providing a complete picture of overall profitability.
4. Formula: Net Profit Margin = (Net Income / Revenue) × 100.
5. Current Ratio: This measures your ability to pay short-term obligations and is an essential liquidity indicator.
6. Formula: Current Ratio = Current Assets / Current Liabilities.
7. Cash Flow: Monitoring your cash inflows and outflows ensures you have enough liquidity to cover operating expenses and invest in growth.
8. Return on Investment (ROI): This metric measures the efficiency of investments, such as marketing campaigns or equipment purchases.
9. Formula: ROI = [(Net Profit from Investment - Cost of Investment) / Cost of Investment] × 100.

Tracking these metrics alongside your EBIT margin provides a well-rounded understanding of your business's financial health.

How does Thriday help you track business performance?

Thriday is an all-in-one financial management platform designed to simplify the lives of Australian small business owners. Here's how Thriday can help you monitor and improve your business performance:

1. Automated bookkeeping: Thriday automatically records your income and expenses, eliminating the need for manual data entry and reducing the risk of errors.
2. Real-time financial insights: With Thriday, you can access up-to-date profit and loss statements, making it easier to track your EBIT, revenue, and expenses.
3. Customised reports: Thriday provides tailored financial reports that help you analyse your EBIT margin and other key metrics. These insights empower you to make data-driven decisions.
4. Integrated accounting tools: Thriday combines banking, accounting, and tax reporting in one platform, streamlining your financial management and saving you time.
5. Simplified EBIT margin calculations: Thriday's intuitive interface makes it easy to calculate and monitor your EBIT margin, ensuring you always clearly understand your business’s financial performance.

Using Thriday, you can focus on growing your business while staying on top of your financial metrics. The platform's automation and real-time insights make it the ideal solution for Australian sole traders and small business owners.

‍

Final thoughts

Understanding and tracking your EBIT margin is vital for the success of your small business. This metric provides valuable insights into profitability and operational efficiency, helping you identify areas for improvement and make informed decisions.

Thriday offers a powerful solution for tracking your EBIT margin and other critical metrics, combining automation with real-time financial insights. By leveraging Thriday's tools, you can optimise your business operations, improve profitability, and achieve your goals. Don't leave your financial performance to chance. Start using Thriday today and take control of your business's success.