EBIT is one of the hottest metrics right now.
And not just because it's easy to understand.
In this post, we're going to tell you all about EBIT.
What it means.
How to calculate it.
And how to use and interpret it.
- What is EBIT?
- What's the difference between EBIT vs. EBITDA?
- What's the difference between EBIT vs. operating income?
- What's the difference between EBIT vs. net income?
- EBIT margin
What is EBIT?
EBIT stands for Earnings Before Interest and Taxes. It's a profitability indicator or a measure of a company's earnings potential.
(EBIT is also referred to as operating earnings, operating profit, or profit before interest and taxes.)
It's also simple to compare: the higher it is, the better.
The EBIT calculation is also super easy: subtract all expenses (except interest expenses and tax expenses) from your company's net income. The resulting difference is your EBIT.
EBIT formula and example calculation
The EBIT formula is super simple.
EBIT = revenue - operating expenses (except any interest expense or tax expense)
Or, put another way:
EBIT = net income + interest + taxes
Another EBIT calculation you might have seen is this:
EBIT = Revenue - COGS (cost of goods sold) - Operating expenses
But as you'll see, this is the formula for operating income.
Anyway, here's a sample way to calculate EBIT:
Net earnings: $1,000,000
Interest expenses: $50,000
EBIT = net earnings + interest + taxes
EBIT = $1,000,000 + $50,000 + $450,000
EBIT = $1,500,000
So as you can see, it's easy to calculate EBIT if you have easy access to your net earnings and interest and tax expenses.
Why is EBIT important to know about?
Investors and other external stakeholders often use EBIT (or its close cousin, EBITDA) to assess a company's profitability.
While EBIT isn't a perfect metric in isolation, it's helpful in context, especially when comparing companies in the same industry.
To get a holistic view of a company's core business operations, investors and other stakeholders also look at a company's financial statements (the income statement, the balance sheet, and the cash flow statement).
They'll also look at that profit and income sliced in a few different ways: a company's gross profit, operating profit, and operating expenses.
A few financial ratios, like return on capital employed (ROCE), use EBIT in their calculations. So it's always a good idea to have your company's EBIT on hand.
Limitations of EBIT
EBIT's biggest limitation is that it excludes the cost of servicing debt.
This means a company can use EBIT to a misleading impression of its financial resilience. That could cause stock prices to rise or entice investors to make a riskier investment than they would otherwise.
That's not to say you should never use EBIT. Nor that you should never trust it.
But you should be aware that a highly leveraged company can report the same EBIT as a company with minimal debt. The company with less debt is the less risky operation, but EBIT doesn't clue you into that.
So always dig a little deeper.
What are interest expenses and tax expenses?
Interest and tax expenses include any interest a company pays and taxes.
Some places where interest expenses might occur include:
- Convertible debt
- Lines of credit (like company credit cards)
Companies should keep interest expenses to a manageable level by maintaining a stable interest coverage ratio, or ratio of EBIT to interest expense. A higher interest coverage ratio means a company can better cover its interest expenses.
Meanwhile, tax expenses might come from:
- Income taxes (sometimes called corporation taxes)
- Sales tax (sometimes called VAT, value-added tax)
- Property taxes
- Excise taxes
- Employment taxes
- Dividend tax
- State income taxes
- Federal income taxes
- Local taxes
The income tax expense is one of the largest, and it's important to factor it into your headcount planning.
What's the difference between EBIT vs. EBITDA?
EBIT is earnings before interest and taxes.
EBITDA is EBIT, but also before depreciation and amortization expenses. Because of this, EBITDA is generally considered a more accurate depiction of a company's operating income.
However, like EBIT, EBITDA excludes the effect of capital expenditure, capital structure, and tax jurisdiction.
So while EBIT includes some non-cash expenses, EBITDA is only earnings minus cash expenses.
That's the key difference, but a few smaller ones are worth discussing.
Use in financial ratios
EBIT and EBITDA get used in different financial ratios. Generally, you'll use EBIT more often.
Financial ratio calculations that include EBIT include EBIT margin, the interest coverage ratio, the fixed interest coverage ratio, the fixed charge coverage ratio, the times interest earned ratio, and the financial leverage ratio.
The only common financial ratios that include EBITDA are the earning margin and the EBITDA multiple. (Which is certainly an important ratio!)
When to report EBIT vs. EBITDA
The best way to decide which to report is to show whichever is higher.
If a company has more fixed assets, its depreciation and amortization expenses will likely be higher. So it'll probably want to report EBIT.
But a company with few fixed assets will be more likely to report EBITDA.
With that in mind, savvy investors will ask for both and compare the two.
(Or they'll ask to see the company's income statement.)
Let's look at an example of a sample company's income and cash flow statements.
Company A's income statement:
|Cost of goods sold (COGS)||$200,000|
|Operating expenses (OpEx)||$100,000|
Company A's cash flow statement:
|Cash flow statement|
|Less: depreciation and amortization||$120,000|
|Less: changes in working capital||$80,000|
|Cash from operations||$1,000,000|
This company has a relatively low level of depreciation and amortization compared to its net income—only 10%.
But let's calculate EBIT and EBITDA for this company.
EBIT = Sales revenue - COGS - OpEx
EBIT = $1,700,000 - $200,000 - $100,000
EBIT = $1,400,000
And now EBITDA:
EBITDA = EBIT + depreciation & amortization
EBITDA = $1,400,000 + $120,000
EBITDA = $1,520,000
Since EBITDA is higher for this company, they might prefer to highlight it as a performance metric.
However, since EBITDA isn't that much higher, there's a case for using both. Since D&A are so low, providing both numbers paints a rosier picture than either in isolation.
What's the difference between EBIT vs. operating income?
EBIT refers to the business’s earnings earned during the period without considering the period's interest and tax expense.
But operating income (or operating profit) refers to the income earned by a business from its principal revenue-generating activities. It does not consider non-operating income and non-operating expenses.
So while EBIT excludes interest and taxes, operating income excludes non-operating income and expenses (like interest and taxes).
How to calculate operating profit
The operating profit/operating income calculation often looks like the EBIT calculation.
Operating income = gross income - operating expenses.
As you know, gross income is just revenue minus COGS (cost of goods sold).
So we can turn the formula into:
Operating income = revenue - COGS - operating expenses.
While the EBIT formula looks like:
EBIT = revenue - operating expenses.
So the major difference between EBIT and operating income is that EBIT includes COGS.
So you could also calculate EBIT like this:
EBIT = Operating income + COGS.
Pretty neat, right?
This also means that EBIT can equal operating income in rare cases where COGS is zero.
Recognition by GAAP
EBIT is not recognized as a GAAP (generally accepted accounting principles) measurement, but operating income is.
While EBIT still has a place, it's not in, for example, government audits.
It also means you should never accept a company's EBIT in isolation. Always consider EBIT in the context of other metrics.
While EBIT is a profitability indicator, operating income is more concerned with raw numbers.
You wouldn't use EBIT to determine how much of your revenue you can convert into profit. You'd use operating income for that.
Likewise, you wouldn't use operating income to show the potential for profitability. You'd use EBIT.
EBIT vs. net income
The difference between EBIT vs. net income comes down to earnings vs. EBIT.
As you know, EBIT is earnings before interest and taxes.
Net income is analogous to earnings.
So the difference between EBIT vs. net income is that EBIT is net income with interest and taxes added back in.
Pretty easy, right?
The EBIT margin, also known as the operating margin, is a financial ratio that measures profitability without considering the effects of interest and taxes.
It's easy to calculate: divide EBIT by sales or net earnings.
A company’s operating margin tells you how much profit it makes after subtracting operating costs.
It measures the company's profit after paying for production costs such as wages and raw materials.
These costs vary over time—they’re not fixed costs. So operating margin is But the operating margin doesn’t consider deductions for interest payments or taxes.
The formula for operating margin is:
EBIT margin = Operating income ÷ Total revenue
EBIT Margin Calculation Example (%)
Say a company's operating profit is $2,000,000 but its total revenue is $10,000,000.
If we plug that into the EBIT margin formula, we get:
EBIT margin = $2M ÷ $10M = 20%.
Whether or not this is a good number to shoot for depends on the industry.
How to interpret EBIT margin
Generally, a higher EBIT margin is considered better than a lower one.
The average total market operating margin is 13.13%, but a “good” operating margin varies across industries and company types as with gross profit margin. Here are some examples:
- Financial services — 17.99%
- Publishing and newspapers — 8.43%
- Software (entertainment) — 33.55%
NYU Stern School of Business has collated data across multiple industries for average operating margins. Check their full list to find the industry closest to yours, to help you benchmark yours.
Conclusion: all about EBIT
You now know how to use EBIT to determine a company's financial health.
You also know how the difference between EBIT vs. EBITDA and other metrics.
But there's more than just calculating EBIT.
After all, you might find it difficult if your numbers aren't always up-to-date.
And that's where Cube can help. Cube connects to all your source systems and to your spreadsheets.
With Cube, it takes barely two minutes to pull data directly from your GL into your Excel model, calculate EBIT, and then push that data to Google Sheets to share with stakeholders.
Interested? Click the image below to request a free demo.