Measure Operating Earnings

To measure operating earnings, an accountant must understand what this term means. This is a fundamental determination in an internal profit statement, meant for managers and executives of a company. It is not for public, or governmental, consumption, and so does not have to be formatted according to the generally accepted accounting principles (GAAP) that govern the annual external report.

"Operating" is an inclusive word that covers all expenses associated with making sales and running the company, except for interest and income tax. Operating earnings, then, is "earnings before interest and income tax" (EBIT). The importance of this figure is that it reveals how the company earned the profit and pinpoints the relationship between sales price and volume, and costs.

The Significance of EBIT

EBIT is an essential indicator of financial health because it discloses whether or not the company has made enough profit to cover its capital outlays. A business must make sales and it must make a profit; in order to make sales, capital expenditures are necessary. These acquired assets cost money, and EBIT tells owners and managers that there is or is not enough profit being made to take care of this cost of doing business.

Not only that, but this internal report zeros in on several vital areas for scrutiny by management. The report spells out variable expenses that increase or decrease along with correlating changes in sales revenue. Variable expenses in this report are separated into those expenses resulting from sales volume, such as shipping, and those from sales revenue, such as commissions to salespeople. These and other financial factors must be subjected to financial analysis in order to measure operating earnings.