I’m calculating EBIT and it was negative in the two years prior to the most recent fiscal year. I’m also calculating EBIT margin. Does negative EBIT margin indicate that the COGS and the SG&A are out of line and too high relative to the amount of sales? I want to explain what it means when EBIT margin changes from a negative amount to a positive amount one year later. Thanks.
EBIT can be thought of as a very rough approximation for Cash Flow from Operations (CFO). If it’s negative, it means that the company isn’t selling enough to cover its fixed costs (assuming that the company isn’t already selling below its variable costs, which would probably only happen in an inventory liquidation). So negative EBIT is a bad thing, because there isn’t enough earnings to cover any expenses. It’s only tolerable in a early stage growth company (probably not public), or possibly a company that has just launched a major new product line. There was an EBITDA question earlier; EBITDA is a very rough approximation for Free Cash Flow, which is about how much cash is left over after sales, variable costs, and capital expenditures are accounted for. If EBIT is positive and EBITDA is negative, then you need to worry that a mature company isn’t making enough to keep its capital needs maintained, and so any profits might not be sustainable when long-lived assets need to be replaced. Again, in a young and growing company, capital expenditures are likely to be proportionally greater as it ramps up capacity, so it’s not as big a worry, but still something one needs to keep an eye on.
There can be so many reasons why EBIT is negative. Just walk through your P&L and see what’s going on. It doesn’t necessarily imply that any of the company’s expenses are “out of line” – for example, startup companies all have negative EBIT because their initial expenses are so high. And also, you have to figure that within those numbers could be D&A as well. The point is, EBIT switching from negative to positive can vary so much depending on the company we’re talking about…but just go through the P&L line by line as well as the company’s filings and you should be able to understand why it changes.
I would disregard bchadwick’s comment because it is wrong. Simple put, the reason EBIT is negative is because expenses exceed revenue. The company could still generate positive free cash flow, although this is unlikely. This means the company must find funding from either investing or financing cash flows (eg. asset or bond/equity sales). Without EBIT turning positive, sourcing from investing or financing cash flows is untenable over the long term (one would hope).
bchadwick Wrote: ------------------------------------------------------- > EBIT can be thought of as a very rough > approximation for Cash Flow from Operations (CFO). > If it’s negative, it means that the company isn’t > selling enough to cover its fixed costs (assuming > that the company isn’t already selling below its > variable costs, which would probably only happen > in an inventory liquidation). So negative EBIT is > a bad thing, because there isn’t enough earnings > to cover any expenses. It’s only tolerable in a > early stage growth company (probably not public), > or possibly a company that has just launched a > major new product line. > > There was an EBITDA question earlier; EBITDA is a > very rough approximation for Free Cash Flow, which > is about how much cash is left over after sales, > variable costs, and capital expenditures are > accounted for. If EBIT is positive and EBITDA is > negative, then you need to worry that a mature > company isn’t making enough to keep its capital > needs maintained, and so any profits might not be > sustainable when long-lived assets need to be > replaced. Again, in a young and growing company, > capital expenditures are likely to be > proportionally greater as it ramps up capacity, so > it’s not as big a worry, but still something one > needs to keep an eye on. If EBIT is positive then EBITDA will also be positive. As a banker I would say the most relevant measure of cash flow from operations is EBITDA followed by EBIT. Basically each measure shows how much cash is left over after funding operating expenses, and particularly from a banker’s standpoint,how much is available to service debt. As a measure of cash flow to determine equity value, I’d say neither is relevant. For eaxample, you have a small company with a great EBITDA. However, for that company to ramp up, it may require a large investment funded by debt, especially if the business is dependent on ongoing capital expenditures. That being the case, the company will borrow to fund that investment. If you add back all the interest and depreciation on those fixed assets, as well as the taxes and any amortization, then the company can show a good EBITDA. But by the time they get done paying off the bank’s interest each month, there’s nothing left for shareholders. This is particularly a problem if the company needs to continually reinvest in capital expenditures and/or repair/maintain its fixed assets. No wonder why the airlines have never made money since the Wright Brothers… competitive pricing and sunstantial ongoing capex. So, when EBIT goes from negative to positive, the change is due to either lower taxes and/or interest, higher earnings, or a combination thereof.
Last portion of my previous statement should read: change is due to lower expenses including amortization and depreciation, higher earnings…
I think most relevant portion of cash flow from operations is exactly that…in other words I prefer to include working capital…personally, prefer a few FCF methods too depending on method/vehicle of invetment…Just my opinion of course…