How to Calculate EBIT (With Definition and Examples)
Updated June 12, 2023
EBIT is one of the metrics analysts use to measure the value of a business. Companies and investors may also use it to evaluate a business's profitability. Understanding the various ways to calculate EBIT can help position you for a career in the finance industry. In this article, we outline how to calculate EBIT, explain what it is, discuss the differences between EBITDA and EBIT, and provide answers to some frequently asked questions.
What is EBIT?
EBIT stands for Earnings Before Interest and Taxes. It's a metric that finance professionals use to measure a company's profitability. This metric focuses solely on how much a company earns from its operations without considering taxes and interest, revealing a more accurate picture of its financial state. EBIT can help investors compare multiple companies operating in the same industry but with different tax rates. It can also help companies identify how much profit they generate and make critical financial decisions, such as how much they can appropriate to pay down their potential debt or how much they can invest in company operations.
How to calculate EBIT
Here are two approaches to guide you on how to calculate EBIT:
1. Calculating EBIT from total revenue
The first way to calculate EBIT is through your total revenue. Total revenue is a company's total income from selling its goods or services to buyers. Once you have the figure, you can deduct the Cost of Goods Sold (COGS) and operating expenses. COGS refers to a company's direct costs to produce the goods it sells. Direct expenses include the cost of materials and labour that go into making the goods and exclude distribution and sales force costs.
Operating expenses include payroll, commission, travel expenses, depreciation, the decrease in value of an asset over its lifespan, and amortization, accounting for the initial cost of an asset over time. The following formula represents this calculation method:
EBIT = Total revenue - COGS - Operating expenses
2. Calculating EBIT from net income
The second way you can calculate EBIT is by using your net income. With this method, you start with your net income, then add your interest and taxes to get your EBIT. Net income refers to a company's revenue from sales after deducting COGS, general expenses, taxes, and interest. The following formula represents this calculation method:
EBIT = Net income + Interest + Taxes
Example of calculating EBIT using total revenue
The following example illustrates using total revenue to calculate EBIT:
Huran Tractors, a company dealing in the sale of tractors, wants to determine its earnings in the middle of the fiscal year. First, it calculates its current total revenue to be $35,000. Then, it determines the cost of goods sold. At the beginning of the fiscal year, it purchased 75 tractors. A month ago, it bought 20 more. In total, the company has sold a total of 70 tractors. The tractors cost $500 each, so its remaining inventory is worth $12,500. Using the income statement, Huran Tractors finds that its total operating expenses for wages, warehouse, and utilities are $5,000. To find EBIT, it used the formula:
EBIT = Total revenue - COGS - Operating expenses
EBIT = $35,000 - $12,500 - $5,000
EBIT = $17,500
Example of calculating EBIT using net income
The following example illustrates using net income to calculate EBIT:
It's the start of a new fiscal year. Danny's Supermart wants to find its EBIT using last year's income statement. Danny's Supermart's net income was $56,780. It paid $2,000 in interest and $4,000 in taxes. To find EBIT, the analyst at the company used the formula:
EBIT = Net income + Interest + Taxes
EBIT = $56,780 + $2,000 + $4,000
Danny's Supermart's EBIT = $62,780
Benefits of using EBIT
Using EBIT may offer the following merits:
EBIT and taxes
EBIT is highly relevant to investors who want to exclude gains from tax cuts from their analysis. Doing this may be essential when comparing multiple companies with different tax situations. By leaving out the tax gains, they can compare the companies equally and gain necessary insights into their profitability.
EBIT and debt
Businesses with fixed assets can demonstrate their actual earnings using EBIT, which leaves out debt associated with their fixed assets. This exclusion is essential because although fixed assets are typically long-term investments with minimal impact on a company's profitability, the associated debt can reflect poorly on its balance sheet. They can give a more accurate overview of their financial state by leaving the debt out.
EBIT vs. EBITDA
Although calculating EBIT is similar to calculating earnings before interest, taxes, depreciation and amortization (EBITDA), they're different in three important ways, including:
EBITDA excludes more deductions than EBIT does. When calculating EBIT, you typically exclude interest and taxes only. In contrast, for EBITDA, your answer excludes interest, taxes, depreciation, and amortization.
The intent behind calculating both metrics differs. Companies typically calculate their EBIT to determine the amount of operating income they generate. In comparison, they use EBITDA to determine the total amount of money flowing in and out of the business.
Both metrics provide different insights into the viability of a company. By using EBIT, business leaders can draw inferences about a company's performance. EBITDA can determine how much spending power a company has to make new investments. Sometimes, a company performing well may have relatively little cash flow to spend. Using EBIT and EBITDA together can help company leaders see an effective financial health overview.
Limitations of EBIT
Since EBIT doesn't factor interest expenses in its calculation, it can exaggerate a company's earning potential, especially if it has significant debt. Similarly, the inclusion of depreciation in calculating EBIT can result in inconsistent results when comparing companies in different industries. If one of the companies you're comparing has significantly more fixed assets than the other, the depreciation expense may skew the comparison favouring the company with fewer fixed assets.
Other important types of profit metrics
In addition to EBIT and EBITDA, here are other metrics you can use to track a company's profitability:
Gross profit: Gross profit is total sales revenue minus the cost of goods sold (COGS). It can indicate the efficiency and effectiveness of a company's production processes.
Net income: Net income is total revenue minus total expenses. It indicates whether a company is making profits on incurring losses.
Gross profit margin: To get your gross profit margin, divide your gross income by revenue and multiply your answer by 100. It indicates a company's profit before subtracting selling, general, and administrative costs.
Net profit margin: To get your net profit margin, you can divide your net income by total revenue and multiply by 100. It indicates whether a company makes enough sales profit and whether the operating and overhead costs are within control.
Here are answers to frequently asked questions about EBIT:
Why is EBIT important?
EBIT is important because it measures a company's profit solely from operations. It offers valuable insight that helps finance professionals, and business leaders understand how well their products and services measurably generate earnings. It can also show growth trends and help investors decide which companies are the best to invest in based on their overall profitability and success.
Financial officers and accountants use EBIT to identify whether a company generates enough earnings to cover expenses like debt and the funding of continued operations while still retaining a profit.
Is EBIT the same as net profit?
Although EBIT and net profit can indicate a company's financial capabilities, both terms aren't the same. EBIT is the amount you get after deducting interest and taxes from your total revenue. Conversely, net profit is the amount you get after deducting all expenses. While professionals use EBIT to determine a business's profitability, they use net income to determine its earnings per share. Also, EBIT is more relevant to equity holders, governments, and debt holders, while net income is more relevant to equity holders.
Is EBIT the same as operating income?
EBIT is different from operating income. Unlike EBIT, operating income refers to what a company has left after deducting operating expenses and other costs from its gross income. It typically indicates what proportion of a company's revenue can turn into profits.
Which is more important, EBIT or EBITDA?
EBIT and EBITDA are equally important as each has its purpose and value. If you want to determine operating income, you can calculate EBIT. Conversely, if you want to assess cash flow, you can use EBITDA. Using both can offer a clearer understanding of a company's financial health.
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