Question

If you want to compare the operations of similar firms without the firm's capital structure or tax status affecting that comparison, which ratio should you use?

Answer 1

We make use of EBIT (Earnings before Interest and Tax)

Step-by-step explanation:

Each company has different capital structure (i.e mixture of equity and debt) that gives its weighted average cost of debt. This is depended on the risk profile of the company and macro economic policy prevailing in its jurisdiction.

At the same time, the tax liability of each company differ at different point in time which is depended on the nature of its transactions and the tax laws operating at its jurisdiction.

It is assumed that firm may not have absolute control over all these variables. Hence, in order to ensure that a fair basis is used in comparing similar firms performance, EBIT is always used as a common ground for comparing performance.