Earnings Before Interest and Taxes (EBIT): Formula and Example (original) (raw)

What Is Earnings Before Interest and Taxes (EBIT)?

Earnings before interest and taxes (EBIT) indicate a company's profitability. EBIT is calculated as revenue minus expenses excluding tax and interest. EBIT is also called operating earnings, operating profit, and profit before interest and taxes.

Key Takeaways

• Earnings before interest and taxes (EBIT) measures a company's net income before income tax and interest expenses are deducted.
• EBIT is used to analyze the performance of a company's core operations.
• EBIT is also known as operating income.
• EBITDA equals earnings before interest, taxes, depreciation, and amortization when calculating profitability.

Investopedia / Daniel Fishel

Understanding Earnings Before Interest and Taxes (EBIT)

EBIT, or operating profit, measures the profit generated by a company's operations. By ignoring taxes and interest expenses, EBIT identifies a company's ability to generate enough earnings to be profitable, pay down debt, and fund ongoing operations.

EBIT is not a GAAP​ metric and not labeled on financial statements but may be reported as operating profits in a company's income statement. Operating expenses, including the cost of goods sold, are subtracted from total revenue or sales. A company may include non-operating income, such as income from investments.

A company may include interest income in EBIT depending on its sector. If the company extends credit to its customers as an integral part of its business, this interest income is a component of operating income. If interest income is derived from bond investments, it may be excluded.

Formula and Calculation

EBIT = Revenue − COGS − Operating Expenses Or EBIT = Net Income + Interest + Taxes where: COGS = Cost of goods sold \begin{aligned} &\text{EBIT}\ =\ \text{Revenue}\ -\ \text{COGS}\ -\ \text{Operating Expenses}\\ &\text{Or}\\ &\text{EBIT}\ =\ \text{Net Income}\ +\ \text{Interest}\ +\ \text{Taxes}\\ &\textbf{where:}\\ &\text{COGS}\ =\ \text{Cost of goods sold} \end{aligned} ​EBIT = Revenue − COGS − Operating ExpensesOrEBIT = Net Income + Interest + Taxeswhere:COGS = Cost of goods sold​

The EBIT calculation combines a company's manufacturing cost, including raw materials, and total operating expenses, including employee wages. These items are subtracted from revenue:

1. Take the value for revenue or sales from the top of the income statement.
2. Subtract the cost of goods sold from revenue or sales, which gives you gross profit.
3. Subtract the operating expenses from the gross profit figure to achieve EBIT.

What EBIT Tells Investors

EBIT is useful in comparing the performances of similar companies in the same industry. EBIT is not a good measure across different sectors. For example, manufacturing companies have larger COGS than service-only companies.

Investors use EBIT to speculate how a business runs without taxes or capital structure costs. EBIT also levels the playing field when investors compare multiple companies with different tax rates.

EBIT vs. EBITDA

EBIT is a company's operating profit without interest expense and taxes. EBITDA or earnings before interest, taxes, depreciation, and amortization uses EBIT without depreciation and amortization expenses when calculating profitability. EBITDA also excludes taxes and interest expenses on debt. But, there are differences between EBIT and EBITDA.

Companies with a significant amount of fixed assets can depreciate the expense of purchasing those assets over their useful life. Depreciation allows a company to spread the cost of an asset over the life of the asset and reduces profitability. Companies with a significant amount of fixed assets must depreciate the expense of purchasing those assets over their useful life. EBITDA measures a company's profits by removing depreciation and reveals the profitability of a company's operational performance before factoring in the impact of its asset base.

Balance Sheet Example of EBIT

Assume all data for Company X represents all figures in millions of USD. To calculate EBIT, subtract the cost of goods sold and the SG&A expense from the net sales. However, consider the other types of income that can be included in the EBIT calculation such as non-operating income and interest income:

1. EBIT=NS-COGS-SG&A+NOI+II
2. EBIT=$65,299-$32,909-$18,949+$325+$182
3. EBIT=$13,948

Where:

• NS=Net Sales
• SG&A=Selling, general, and administrative expenses
• NOI=Non-Operating Income
• II=Interest Income

A company can exclude one-time expenses. In this case, the company was continuing to operate in the country through subsidiaries. Due to capital controls in effect at the time, Company X took a one-time hit to remove foreign assets and liabilities from its balance sheet.

There is also an argument for excluding interest income and other non-operating income from the equation. For some companies, the amount of interest income they report might be negligible and can be omitted. Other companies, such as banks, generate a substantial amount of interest income from the investments they hold in bonds or debt instruments.

A second way to calculate Company X's EBIT is to work from the bottom up, beginning with net earnings. We ignore non-controlling interests, as we are only concerned with the company's operations and subtract net earnings from discontinued operations for the same reason. We then add income taxes and interest expenses back in to obtain the same EBIT we did through the top-down method:

1. EBIT=NE-NEDO+IT+IE
2. EBIT=$10,604-$577+$3,342+$579
3. EBIT=$13,948

Where:

• NE=Net Earnings
• NEDO=Net Earnings from discontinued operations
• IT=Income Taxes
• IE=Interest Expense

Why Is EBIT Important?

EBIT is a measure of a firm's operating efficiency. Because it does not account for indirect expenses such as taxes and interest due on debts, it shows how much the business makes from its core operations.

What Are the Limitations of EBIT?

Depreciation is included in the EBIT calculation and can lead to varying results when comparing companies in different industries. A company with significant amount of fixed assets will have greater depreciation than a company that has few fixed assets. Since the depreciation expense reduces operating profit (also called EBIT), the company with more fixed assets will have a lower like-for-like profit. By removing the depreciation and calculating EBITDA instead of EBIT an analyst can get a better apples to apples comparison of the two companies' operating profits.

How Is EBIT Calculated?

EBIT subtracts a company's cost of goods sold (COGS) and its operating expenses from its revenue. EBIT can also be calculated as operating revenue and non-operating income, less operating expenses.

What Is the Difference Between EBIT and EBITDA?

EBIT and EBITDA remove the cost of debt financing and taxes, while EBITDA goes further and adds depreciation and amortization expenses back into profit. Depreciation is not captured in EBITDA so it is a better profit metric to use to compare companies with different asset bases.

How Do Analysts and Investors Use EBIT?

EBIT is used in several financial ratios in fundamental analysis. The interest coverage ratio divides EBIT by interest expense, and the EV/EBIT multiple compares a firm's earnings to its enterprise value.

The Bottom Line

Earnings before interest and taxes (EBIT) help measure a company's profitability and is calculated as revenue minus expenses excluding tax and interest. EBIT is also called operating profit. EBIT helps investors compare the performances of similar companies in the same industry, but it is not a good measure across different industries.