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Earnings before interest and taxes measures a company's profitability. The formula is revenue minus expenses excluding interest and taxes. In this post, we go through the definition, formula, examples, and compare EBIT to EBITDA.

What is EBIT?

Earnings before interest and taxes (EBIT) is a profitability measure that is used to understand the profit generated by a company’s main business.The formula is revenue minus expenses excluding interest expense and tax expense. EBIT is also called operating profit or operating income.
There are several views into the profit that a business generates: earnings before interest, taxes, depreciation, and amortization (EBITDA), earnings before interest and taxes (EBIT), and net income (NI).
The two ways to calculate EBIT are EBITDA minus depreciation minus amortization, or net income plus interest plus tax.
At a high level, the goal of the income statement is to solve for the net income or net loss value.However, a company’s bottom line could not be representative of the underlying business health for a number of reasons.

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 Definition

EBIT is a company’s net profit before income tax expense and interest are deducted.This metric is also called operating profit because it shows the profit led after deducting all operating expenses.

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.

EBIT Formula

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.

Total Revenue: The amount of income generated from customers. This might also be referred to as total sales or sales revenue.
Cost of Goods Sold: The direct labor and direct material costs associated with generating revenue. This is often abbreviated to COGS.
Gross Profit: Total revenue less cost of goods sold. Gross profit shows how much money is left after accounting for direct costs. Gross profit is used to cover overhead and, hopefully, generate a profit.
Selling, General, and Administrative Costs: The overhead associated with running a business, including sales, marketing, and administrative costs.
Earnings Before Interest, Taxes, Depreciation, and Amortization: A measure of profitability that does not include the impact of non-cash items, interest expense, or income taxes. Not a GAAP metric. Often abbreviated to EBITDA.
Non-Cash Expenses: Accounting expenses that do not actually impact cash, such as depreciation and amortization.
Earnings Before Interest and Taxes: A measure of profitability that includes depreciation and amortization, but not interest and taxes. Not a GAAP metric. Often abbreviated to EBIT.
Interest & Tax Expenses: The interest and tax payments made in a given accounting period. These items are found on the bottom of the income statement and vary based on the tax situation and capital structure of the individual business.
Net Income: Total revenue minus total expenses. This value is also called the bottom line or net profit of a business.

EBIT Examples

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

  • Revenue: $10,000,000
  • COGS: $2,500,000
  • SG&A: $6,500,000

Company A FY2021

  • Revenue: $13,000,000
  • Net Income: $1,100,000
  • Interest Expense: $300,000
  • Tax Expense: $220,000

Company A FY2022

  • Revenue: $16,000,000
  • EBITDA: $2,200,000
  • Depreciation: $300,000
  • Amortization: $150,000

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

A company can improve its EBIT by growing revenue, decreasing cost of goods sold, and decreasing operating expenses. Note that having less debt (and thus, less interest expense) would not impact this value.

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.

When is EBIT Used?

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.

EBITDA vs. EBIT vs. Net Income

These three metrics are all different measures of a company’s profit. Let’s explore the relationship between them a little further.

While EBIT and EBITDA are not required on the income statement, we can create our own statement that include them.
EBITDA is revenue minus the cost to generate revenue (cost of goods sold) and the cost to run the business (sales, general, and administrative expenses). Of the three profit metrics, this is the furthest up the income statement.
EBITDA accounts for the cash expenses only. Meanwhile, EBIT accounts for the non-cash expenses by also removing depreciation and amortization. This metric appears lower down on the statement..
Lastly, net income removes interest and taxes from EBIT. This metric factors in all expenses that a business incurs.

Final Thoughts

Investors, analysts, small business owners, and managers use EBIT to understand the performance of a company. EBIT is not a required GAAP metric and it’s a calculated value derived by a company’s income statement.

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:

  • EBIT is a metric not required by GAAP but is very helpful to understand the profitability of a company’s core operations
  • It’s calculated by adding interest and taxes to net income, or by removing depreciation and amortization from EBITDA
  • EBIT margin is earnings before interest and taxes divided by total revenue
  • Companies with different capital structures have different interest expenses, it’s important to remove these variables so we can company the fundamentals of two businesses in the same industry
  • There are some limitations to EBIT, including the fact that two analysts could compute slightly different EBIT values

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.

A similar metric is EBT, which stands for earnings before taxes. EBT would appear lower on the income statement than EBIT, as it includes interest payments. For companies with no debt on the balance sheet, these values would be the same.
Investors and analysts will provide these custom views into a business to understand how different pieces are functioning. Removing certain variables can help provide unique insights into a potential investment.

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.

It’s important to note that an analyst’s or investor’s discretion is used when calculating these metrics. A company might have net-30 payment terms and charge fees for paying invoices late. It’s up to the discretion of the individual to include or not include these late fees as operating income.

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.

There are also some limitations of EBIT. This is a useful tool for understanding the long-term growth of companies, it’s helpful when tracking the same business year over year.

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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