Income before tax (EBIT) = Operating profit – Gain/loss on sale of assets – Other items
Tax expense – It is simply the tax owed by the company to the government
Net Profit = Income before tax – Tax expense
Net Profit is the widely watched item when the earnings results are announced for a company. Whilst growth in absolute numbers is good to watch, it is also advisable to see this number as a percentage of Revenues, i.e. what percentage of Revenues in the concerned period was actually translated into profit that the owners of the company could use for themselves or invest it back in the growth of the company. This measure is called Net Profit Margin (%), expressed as below:
Net Profit Margin (%) = Net Profit/ Revenues
As would be obviously clear by now, more the net profit margin, the better investment it would be.
Please see below the example for Gilead Sciences (GILD) to see the trends of profit margins. Except for a period between 2012 and 2013 when margins dropped to late 20s (which also is arguably very good), the company has been able to maintain margins above 35%.
Chapter 9 – Balance Sheet basics