Earnings before Interest and Taxes (EBIT)
The measure of a firm’s profit in a given year that excludes income tax expenses and interest in accounting and finance is widely known as EBIT or Earnings before Interest and Taxes.
For those not conversant with accounting lingo: generally, EBIT is the difference between operating revenues and operating expenses. In the same vein, EBIT is all profits before taking into consideration interest payments and income taxes. When an entity does not have non-operating income, then operating income is used for EBIT and operating profit. EBIT is also referred to as ‘Operating Earnings’, ’Operating Profit’, or ‘Operating Income’.
Earnings before Interest and Taxes has a simple formula when computing or calculating:
_ EBIT = Revenue – Operating Expenses (OPEX) + Non-Operating Income
While the Operating Income is got by subtracting Operating expenses from the Revenue realized. That is:
_ Operating income = Revenue – Operating Expenses (OPEX)
To compute EBIT, expenses e.g. cost of goods that are sold, and any administrative expenses are also factored in then subtracted from revenue. The profit is obtained by subtracting the interest and taxes from the outcome.
EBIT is also used across the board by many companies especially in cross-company comparisons as it excludes both taxes and interest expenses saving one the agony of analyzing different company structures and tax rates and thus enabling smooth translation and calculation breakdown of numerical figures that crop up from time to time.
A relevant example of how EBIT is used on a daily basis would be to compute how a professional investor who is contemplating a change to the capital structure of a firm, say, through a leveraged buyout evaluates a firm’s basic earnings potential and then determines the use of debt versus equity (shares) to make an informed choice.
It’s important to note that:
- EBIT is a non-GAAP measure that represents earnings before income taxes
- EBIT Margin is a measure of EBIT as a percentage of net sales and
- EBIT is a precursor for EBITDA (Earnings before interest, taxes, depreciation and Amortization.
A typical income statement breaks down perfectly how the EBIT was generated. This would include: Revenue (sales revenue); Operating Expenses (cost of goods sold etc.); Operating Income; Net Income.
Earnings before interest and taxes (EBIT) is a vital tool for anyone planning to balance their books professionally and should be known by heart by all Accounting Basics.