What Is EBIT?

EBIT Explained in Less Than 4 Minutes

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Earnings before interest and taxes, more commonly referred to as EBIT, is a standard accounting term identifying a business’s operational performance. EBIT defines a business’s net income and does not include its income tax or interest expenses.

Learn about EBIT, how accountants calculate it, and why businesses often prefer to use it to share their performance with creditors and investors.

Definition and Examples of EBIT

EBIT is an acronym for earnings before interest and taxes. Accountants use EBIT to identify a business’s net income before deducting expenses such as income tax and interest. EBIT is a non-GAAP measure—meaning it is not a traditional accounting principle. It is used to share a company’s operational earnings and ability to generate a profit. 

EBIT can be used in two ways. First, it is used within a company by decision-makers who want to evaluate its operational performance and profit. EBIT is also used by investors who want to understand a company’s profit.

When evaluating a company’s EBIT, compare the current year’s income with previous years’. The current revenue and EBIT will help identify trends in a business’s profitability.

  • Alternate names: Operating earnings, profit before interest and taxes 
  • Acronym: EBIT

There are two formulas for calculating EBIT. The first is considered a direct definition of EBIT because revenue is adjusted with all related expenses. It looks as follows:

Earnings - Cost of Goods Sold - Operating Expenses = EBIT

The second formula is considered indirect because it shows us what needs to be added to the net income. It’s calculated this way:

EBIT = Net Income + Income Tax + Interest Expense

Although both equations will end with the same net income, the formulas are used for different reasons. The first is used to measure operational performance, while the second is analyzing profitability.

Let’s explore an example of both EBIT formulas in action. Beautopia is a company that manufactures wigs, which are later sold in retail spaces. This year, its income statement shows the following:

  • Earnings: $1,000,000
  • Cost of Goods Sold: $600,000
  • Gross Profit: $400,000
  • Operating Expenses: $100,000
  • Interest Expense: $50,000
  • Income Tax: $50,000
  • Net Income: $200,000

Using both formulas, Beautopia’s EBIT comes to $300,000.

How EBIT Works

EBIT is categorized as non-GAAP earnings, meaning it is not recognized as a generally accepted accounting principle. Non-GAAP is considered an alternative to traditional accounting methods as it measures a company’s earnings. A company’s EBIT is performed at the end of the fiscal year using data included in its income statements.

It is essential to understand the industry standard when setting an EBIT benchmark. Comparing the operating profits of other companies within your industry will provide a robust analysis that can help guide you in setting your own business's EBIT benchmark.

The purpose of EBIT is twofold. Businesses often use EBIT internally to make decisions related to the operation and management of their company. By evaluating earnings, cost of goods sold, and expenses, a company can identify how to save and make more money within their business.

Investors also use a company’s EBIT to understand that company’s profit. By analyzing operating earnings instead of net income, investors can realize profitability without considering the interest expense or income tax. Investors analyze the EBIT metrics of various companies within an industry when they want to understand operational profit and performance. The EBIT metrics can help them decide whether or not to invest in a company.

For instance, say an investor is interested in two companies that manufacture wigs. They will need to look at the gross profit, net income, and operating expenses of each to understand the businesses’ true profitability.

Finally, EBIT is included in various financial ratios developed by companies. These calculations have an interest coverage ratio as well as an operating profit margin.

Key Takeaways

  • EBIT is the acronym for earnings before interest and taxes. It is a business’s net income and does not include deductions such as income tax and interest expenses.
  • The purpose of EBIT is to analyze a company’s performance based on its operations so that investors can have an understanding of its profitability.
  • Company decision-makers can also use EBIT internally to gain a clear understanding of a business’s operational performance and profit.
  • EBIT is also referred to as operating earnings or profit before interest and taxes.