EBIT (Earnings Before Interest and Taxes) is a measure of a company’s profitability. It calculates a business’s operating profits by deducting operating expenses and the cost of goods sold from its net revenue.
This calculation is relatively simple as it does not consider taxes or interest. Investors and creditors use this value to see how successful a company’s operations are regardless of its taxes payable or capital structure. Investors can look at a business’s EBIT to check if it can generate profits.
The following sections will discuss this profitability metric in more detail.
What is the Meaning of EBIT?
EBIT discloses a company’s net income before interest and income taxes are subtracted. To calculate this, one must subtract a company’s cost of goods sold (COGS) and operating expenses from its revenue. Another way to calculate EBIT is to add the company’s operating revenue and non-operating income and subtract operating expenses. EBIT is also called operating profit as they both measure income without considering taxes and interests.
EBIT is a useful metric that shows a business’s earnings from operations while ignoring complex variables such as tax expenses and capital structure costs. It helps in identifying a company’s capabilities to be profitable, carry on operations and pay off its existing debt. Furthermore, investors can get an idea if a particular company would likely be successful in implementing its ideas.
For example, investors can look at the EBIT of a manufacturer of children’s toys to determine if its products are making profits. It helps to look at a company’s financial health without considering the cost of the manufacturing plant or capital distribution.
Formula for EBIT Calculation of a Company
There are several formulas for calculating the EBIT of a company. These are as follows:
A. EBIT = Revenue – COGS (cost of goods sold) – Operating Expenses
COGS represents the total cost of making the goods for sale and includes the cost of shipping, labor, and raw materials. Operating expenses include expenses involved in a business’s normal operations such as marketing, rent, inventory costs, etc.
B. EBIT = Gross Profit – Operating Expenses
Gross profit is a company’s revenue after deduction of the cost of goods sold (COGS). If this value is available, one can simplify the previous calculation by using the above formula.
C. EBIT = EBITDA – (Depreciation + Amortization)
In this method, one finds out the EBITDA (earnings before interest, taxes, depreciation, and amortization) metric from a company’s cash flow statements. Then, they have to deduct the depreciation (loss in value of tangible assets) and amortization (loss in value of intangible assets).
Understanding EBIT Calculations with Examples
Now let us look at some examples for calculating EBIT:
A. ABC Ltd is a company that produces various electronic components. At the end of the financial year, it earned Rs. 55 crore in revenue while spending Rs. 15 crores in acquiring raw materials. Its overhead expenses, including sales, administrative and general expenses, were Rs. 5.5 crore.
The following is the calculation of EBIT for ABC Ltd:
EBIT = Rs. 55,00,00,000 – Rs. 15,00,00,000 – Rs. 5,50,00,000 = Rs. 34,50,00,000
Therefore, this company will have an EBIT of Rs. 34.5 crore for the financial year.
Importance of EBIT in Calculating Profitability
- Investors and lenders can look at a company’s ability to examine a company’s core operations using EBIT. This is because this metric focuses solely on the company’s operations and thus, its ability to be profitable and fund ongoing operations.
- It shows the efficiency and success of a company’s operations without considering the cost of debt. It tells about the company’s financial position from its operations.
- Investors can compare the EBIT of different companies in the same industry. They can also compare it with the previous year’s values to check for trends.
- EBIT is useful for computing various financial values like operating profit margin and interest coverage ratio.
- Investors can use EBIT to compare different companies in the same industry but different tax situations. For example, there are two companies, A and B, with similar net profit, but A had higher EBIT. If A received a tax cut or the country where it operates lowered its taxes, it would have higher profits.
Differences between EBIT, EBITDA, and Operating Profit
EBITDA excludes interest expenses, tax payments, and costs of amortization and depreciation. The latter two values reflect a company’s past investments instead of purely present-day profitability. Depreciation allows companies to spread the cost of buying assets over many years.
However, including these values lead to profit distortions as they are non-cash expenses. This is especially significant for companies with substantial depreciation expenses and a large number of fixed assets. Unlike EBITDA, EBIT only excludes interest and tax expenses; it captures both the information of amortization and depreciation.
While EBIT and operating profit are two terms used interchangeably, they can become different if a company has non-operating income. EBIT includes income from activities not directly related to a company’s core business, i.e non-operating income like income from selling assets or investments.
Another difference is how one views EBIT and operating profit.
One calculates the EBIT from the bottom-up using net income, also called the bottom line. Line items that appear higher i.e interest costs and taxes are added to the net income for EBIT. On the other hand, one calculates operating profit from a top-down approach. This includes taking the value of revenue (a top-line item) and subtracting COSG and operating expenses.
Final Word
EBIT (earnings before interest and taxes) is a metric that focuses solely on a company’s ability to generate revenue from operations while ignoring variables like taxes and interest expenses. It helps to examine if a company’s business activity and ideas would work in real-world applications. It is also used for calculating financial ratios like operating profit margin and interest coverage ratio.