EBIT (Earnings Before Interest and Taxes) helps measure a company’s profitability. It is derived by subtracting expenses, excluding tax and interest, from the total revenue. EBIT is often referred to as operating earnings, operating profit, and profit before interest and taxes.
Imagine you’re a small business owner eager to assess your company’s profitability and compare it with others in your industry. You also aim to attract potential investors. Understanding how to calculate your Earnings Before Interest and Taxes (EBIT) can prove invaluable in achieving these goals.
Decoding EBIT
EBIT shows how much money a company makes from its core activities. It doesn’t consider taxes and interest costs, revealing if the company can earn enough to cover debts and run smoothly.
EBIT isn’t an official accounting term but can be found in a company’s income statement as operating profits. It’s calculated by subtracting operating expenses (like the cost of goods sold) from total sales. Sometimes, non-operating income, such as investment profits, is included.
Interest income might be part of EBIT, depending on the company’s industry. If a company lends money as part of its business, this interest income is included. But if it comes from bond investments, it might be left out.
Formula and Calculation
EBIT = Revenue – COGS − Operating Expenses
Or
EBIT = Net Income + Interest + Taxes
Where:
COGS = Cost of goods sold
Here’s how you calculate it:
- Start with the total revenue or sales from the income statement.
- Subtract the cost of goods sold from the revenue to get the gross profit.
- From the gross profit, subtract the operating expenses to find EBIT.
Another way to calculate EBIT is by adding net income, interest, and taxes. In both methods, EBIT provides a clear picture of a company’s earnings before considering interest and taxes.
EBIT vs. EBITDA: What’s the Difference?
EBIT and EBITDA are financial measures that help us understand a company’s profitability by excluding certain costs and expenses. EBIT focuses on a company’s operating profit and ignores interest and taxes. On the other hand, EBITDA, or Earnings Before Interest, Taxes, Depreciation, and Amortization, takes EBIT and adds back depreciation and amortization expenses.
*amortization is the process of repayment of debt through periodic installments over a period of time.
Depreciation is an accounting method used to spread the cost of assets over their useful life, like buildings or machinery. It reduces a company’s profit on paper, especially for businesses with lots of fixed assets and significant depreciation costs. The more a company spends on depreciation, the more EBITDA will be boosted because it adds back these expenses. Depreciation is essential for companies with many fixed assets but can affect net income. EBITDA gives us a clearer picture of a company’s operational profitability by removing the impact of depreciation.
| EBIT | EBITDA |
| Excludes Interest and Taxes | Excludes Interest, Taxes, Depreciation, and Amortization |
| Reported by companies with good operating profits | Used by companies with large investments in fixed assets and debt |
| Measures business profit, comparable to operating income | Measures business profit, comparable to operating income |
Example of EBIT and EBITDA
| COMPANY A INCOME STATEMENT | |||
| Revenue | $172,052.00 | ||
| COGS | $61,939.00 | ||
| Gross Profit | $110,113.00 | ||
| Expenses | |||
| Salaries and Benefits | $29,249.00 | ||
| Rent and Overhead | $10,000.00 | ||
| Depreciation and Amortization | $15,003.00 | ||
| Interest | $500.00 | ||
| Total Expenses | 54,752.00 | ||
| Earnings Before Taxes (EBT) | 55,361.00 | ||
| Taxes | 15,501.00 | ||
| Net Earnings | 39,860.00 | ||
Take a look at the example of a small business, called Company A. To determine EBIT, deduct the Cost of Goods Sold (COGS) from the Revenue, along with all other expenses except for interest.
EBIT=Revenue−COGS−Total Expenses (excluding interest)
EBIT=$172,052.00−$61,939.00−($29,249.00+$10,000.00+$15,003.00)
EBIT=$172,052.00−$61,939.00−$54,252.00
EBIT=$55,861.00
To calculate EBITDA in this example, simply combine the calculated EBIT with the Depreciation and Amortization figures.
EBITDA=EBIT+Depreciation and Amortization
EBITDA=$55,861.00+$15,003.00
EBITDA=$70,864.00
So, in this example, the EBIT for COMPANY A is $55,861.00, and the EBITDA is $70,864.00.
Importance and Limitations of EBIT
EBIT serves as a metric for evaluating a company’s operational efficiency by focusing solely on core operations and excluding indirect expenses like taxes and debt-related interest. Including depreciation in EBIT can create discrepancies when comparing companies from different industries. For instance, a business with extensive fixed assets can experience reduced profit due to depreciation, which will impact their net income. Similarly, companies burdened with substantial debt face significant interest expenses. EBIT eliminates these interest costs, potentially inflating a company’s earnings, especially in the presence of considerable debt.
What EBIT Reveals to Investors and Analysts
EBIT is a valuable tool for comparing the performance of similar companies within the same industry, providing insights into their operational efficiency. However, it’s not an effective measure when comparing companies across diverse sectors. For instance, manufacturing companies typically have higher Costs of Goods Sold (COGS) compared to service-only firms. Moreover, businesses in capital-intensive industries often rely on debt financing with significant interest expenses due to their substantial fixed assets.
Investors use EBIT to assess a business’s operational performance, excluding the impact of taxes and capital structure costs. It levels the comparison field when evaluating companies with varying tax rates. EBIT finds application in various financial ratios in fundamental analysis, such as the interest coverage ratio (EBIT divided by interest expense) and the EBIT/EV multiple, which compares a firm’s earnings to its enterprise value.
Conclusion
EBIT stands as a pivotal measure of a company’s profitability, providing a clear view of its core operational performance by excluding taxes and interest. It serves as a valuable tool for comparing similar companies within the same industry, aiding investors in understanding how well a business operates without the influence of tax rates or financial structure costs.
However, its utility diminishes when applied across diverse sectors due to variations in costs, particularly in businesses with significant fixed assets. EBIT’s exclusion of interest costs can inflate a company’s earnings, especially for firms burdened with substantial debt, potentially misleading investors. Despite its limitations, EBIT remains important in analysis, contributing to financial ratios like the interest coverage ratio and the EBIT/EV multiple, offering valuable insights for investors and analysts alike.