What is EBIT?
Definition: Earnings Before Interest and Taxes (EBIT) is a financial metric that provides valuable information on the profit metrics of the underlying business or company.
Referred to as operating earnings, the measure provides a clear idea on a company’s ability to earn profits from its operations.
Earning Before Interest and Taxes Explained
Earnings Before Interest and Taxes, looks into business profitability, by subtracting’ expenses from revenues. Likewise, the metric gives a baseline for profitability and not the whole of the picture given the exclusion of interest and taxes in the computation. The exclusion of taxes and interest expense, therefore, provides a clear view of a firm’s ability to generate earnings.
Businesses, as well as companies, have tax and capital interest obligations that many at times make it difficult to see the actual profitability picture. More debt in the books of accounts affects the bottom line upon its deduction but does not provide an actual picture of the underlying performance. Therefore by excluding taxes and interest payments, one is able to get a clear picture of performance.
EBIT Formula
When it comes to calculating EBIT, one must take into consideration the cost of manufacturing goods and services in the form of raw material costs labor costs, etc. Similarly one must take revenue or sales from the top of the income statement
Conversely: EBIT = Revenue- Cost of Goods Sold- Operating Expenses
or
EBIT = Net income + Interest + Taxes
Dividing EBIT with sales revenue gives rise to operating margin often expressed as a percentage
EBIT Example
Company XYZ is engaged in the production of smartphones. Its revenue at the end of the first quarter totaled $5 million. The cost of goods sold, which is the cost incurred in producing the smartphones worth $5 million, was $1.5 million. the company also incurred other overhead expenses in the form of sales, general and administrative expenses amounting to $750,000
Conversely Earnings Before Interest would amount to
EBIT = $5,000,000- $1,500,000- $750,000= $2,750,000
It is clear that company XYZ generated $2.75 million in earnings from its operations
EBIT Analysis and Uses
EBIT is excellent for investors who want to compare various companies with differing tax situations. For instance, a company that has receives preferential tax treatment may appear more profitable than another company. Therefore, measuring earnings before interest and taxes can help compare the profit metrics of different companies.
Conversely, EBIT provides an easy and reliable way of comparing business performance to its competitors, especially where different capital structures and tax debts are involved. By comparing EBIT with that of the industry average, one would get a clear picture on how the core business is performing.
Similarly, EBIT is a valuable measurement tool when it comes to comparing companies in capital intensive industries. Such businesses are known to invest in big equipment for manufacturing operations. Such equipment comes with high interest expenses than must be factored when it comes to calculating earnings.
However, given that high interest, fixed assets are crucial in facilitating long term growth, it is important to strip out the debt associated with them when it comes to ascertaining whether underlying operations are profitable.
EBIT vs EBITDA – What’s the Difference?
Earnings Before Interest and Taxes and Earnings Before Interest Taxes, depreciation and amortization are important financial metrics. However, they differ given that EBITDA also excludes debt financing depreciation and amortization, unlike EBIT. Likewise, EBITDA allows managers and investors to get a better sense of the profitability of the core business.
However, EBITDA might provide a distorted view of profitability in companies with a good number of fixed assets as it does not take into consideration depreciation and amortization. Therefore EBITDA tends to be much higher than EBIT.
Summary
Earnings Before Interest is a financial metric that ascertains a company’s profitability from its underlying operations. The metric takes into consideration all the revenues or sales generated minus costs of goods sold, among other expenses, while excluding interest and tax payments.