For example, a company might have a significant amount of depreciation in a particular month period and that could make its bottom line appear too low.
Similarly, a company might be very profitable but have a heavy debt load with high interest payments. An acquirer could purchase this company, pay off the debt, and it could instantly be a more profitable operation.
That’s why it’s helpful to separate things like the cost of debt financing or the impact of non-cash transactions from a company’s profits.
In summary, EBIT shows the performance of a company without the costs of the capital structure and tax burdens.
EBIT is not required under the United States Generally Accepted Accounting Principles (GAAP), so companies are not required to provide the value on their financial statements.
That means it's the role of internal managers or financial analysts to calculate EBIT from the values provided on a company’s income statement.
EBIT is further down on the financial statement than EBITDA. Both EBIT and EBITDA were created to provide a better view into the operational performance of a company.
As a note, remember that non-operating income and non-operating expenses are not factored into these calculations.
If a company has a one-time sale of an asset or an investment, you want to back that out of the revenue. Similarly, if there is an irregular expense, you will want to exclude that.
EBIT and EBITDA exist to understand a company’s profit from its core business. It removes extraordinary items that could be distracting or could alter the financial analysis.
For instance, a manufacturing business would want to understand the sales generated and costs incurred from its core operations – without being skewed by debt, one-time occurrences, or things like foreign exchange rate.
There are two common ways of calculating earnings before interest and taxes. The first EBIT formula starts with EBITDA then subtract depreciation expense and amortization expense.
The second EBIT formula starts with net income and adds back interest expense and tax expense.
EBIT = EBITDA - Depreciation - Amortization
EBIT = Net Income + Interest Expense + Tax Expense
Depending on what information you are given, it will be faster to calculate the metric using one method or another. But both formulas will give you the same end result.
Keep in mind that this value is always reported as a currency. There is a related metric, EBIT Margin, which looks at EBIT as a percentage of total revenue.
Now let’s look at the income statement, starting at the top of the income statement.
Now that we know the definition, let’s go through a few examples of the EBIT calculation. We will walk through three fiscal years of Company A.
Company A FY2020
Company A FY2021
Company A FY2022
Now let’s dig into the math. Company A gives us COGS and SG&A, so we need to work down the income statement.
FY2020 = Revenue - COGS - SG&A
FY2020 = $10,000,000 - $2,500,000 - $6,500,000
FY2020 = $1,000,000
In fiscal year 2021, we are given the bottom line and we need to add back interest and taxes.
FY2021 = Net Income + Interest + Taxes
FY2021 = $1,100,000 + $300,000 + $220,000
FY2021 = $1,620,000
Lastly, for fiscal year 2022, we start with EBITDA then remove the non-cash expenses.
FY2022 = EBITDA - Depreciation - Amortization
FY2022 = $2,200,000 - $300,000 - $150,000
FY2022 = $1,750,000
Note that a company with a lower cost of capital and a similar core business could have a very different net profit value than a competitor.
For instance, the company with the lower cost of capital could purchase fixed assets at a much lower cost because their financing costs are lower. This means more assets, more revenue, and lower interest expenses.
A company’s operating profit is a valuable metric to a number of stakeholders. Everyone from C-level executives and managers to financial analysts, investors, and creditors will find value in EBIT.
At its core, EBIT shows a company’s earnings and if the main business operation is stable enough to support its expenses.
Since different businesses will face different tax rates, it’s useful to remove the impact of income taxes when evaluating companies. This is one scenario when EBIT is helpful.
Moreover, some businesses are very capital intensive, such as the manufacturing industry, the oil and gas industry, and the transportation industry. Businesses in capital intensive industries will have high interest expenses, since they rely heavily on debt to finance these assets.
By removing debt and the resulting interest expense from the equation, you can compare the underlying operations of multiple players in the same industry.
Calculations such as EBIT and EBITDA are also helpful to create projections in light of a merger, a tax break, or another structural change. It’s easier to forecast the underlying business than to anticipate how all these details will play out.
These three metrics are all different measures of a company’s profit. Let’s explore the relationship between them a little further.
This value is also referred to as operating profit or operating income since it shows the profitability of a company’s ongoing operations (without factoring in taxes or the capital structure).
EBIT strips out these extra items so we can evaluate the company’s ability to generate profit from its operations.
Here is a summary of EBIT:
Since earnings before interest and taxes occur before payments to cover financing, it’s a useful measure to track if a business has enough earnings to cover its expenses, generate a profit, make debt payments, and fund future growth.
For example, is a business not profitable because it’s rapidly growing, has high tax burdens, a large amount of debt, or simply because its core business is not running well?
Metrics such as gross profit, EBITDA, EBIT, EBT, and net income will shed light on different parts and can be used together to better understand companies’ operating performance.
By the same token, companies may have one-time adjustments for restructuring or reorganizing that might need to be taken out before comparing multiple periods to one another.
But there is less value when trying to compare companies across different industries or different geographies. For example, an oil and gas company in the United States might have very different tax situations and tax breaks than a competitor based in the European Union.
This could make the bottom line look very different for these two companies, despite their core operations being similar.
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