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# EBIT: Earnings Before Interest And Taxes

Updated: Mar. 08, 2022

EBIT is the acronym for earnings before interest and taxes. This income statement line relates to the profitability of a company's business. EBIT may also be referred to as profit before interest and taxes. It is often conflated with Operating Income but has some key differences that we’ll review.

## What EBIT Is

Business owners and investors frequently pay attention to EBIT, which is a company's earnings before interest and taxes. EBIT appears on a company's income statement, and its measurement assists business owners and investors in assessing profitability. EBIT answers the question of how much of a company's revenues remain after operating expenses are deducted.

If a company's EBIT is negative, the managers will either have to curb expenses or increase revenues to have a chance at becoming profitable.

## EBIT Formula and Calculation

The EBIT formula subtracts the cost of goods sold (COGS) and operating expenses from the gross revenue. The formula looks like this:

EBIT = Gross Revenue - COGS - Operating Expenses

Cost of Goods Sold is found on the income statement just below revenues. There may be multiple lines that make up the COGS section and could include materials and labor costs. The operating expenses will be the next section and include overhead such as rent, equipment leasing, marketing, insurance, and research and development.

For example, ACME Widget Store spends \$1 to create a widget. They make 1 million widgets in a quarter, but sell 800,000 of those widgets for a price of \$2 per widget. Gross revenues are thus \$1,600,000, while COGS for the quarter is reported as \$800,000. On top of the COGS, they spend \$12,000 per quarter in rent, \$20,000 per quarter in sales and marketing, \$3,000 per quarter on insurance, and \$5,000 in equipment leasing. Adding these costs together means that the company has \$40,000 in operating expenses for the quarter.

To determine the quarterly EBIT of ACME Widget Store, subtract the COGS and operating expenses from the gross revenue (EBIT = \$1,600,000 - \$800,000 - \$40,000 = \$760,000).

## How EBIT Is Used

EBIT is a measure of a business’ operational profitability. It excludes taxes and interest so that the measure focuses solely on earnings from business operations. EBIT levels are dependent on volume of sales, product pricing, and cost efficiency.

EBIT isn’t only used internally to determine profitability. It is often used in conjunction with Enterprise Value (EV) by investors and analysts to assess a company’s relative value. Some investors are interested in how much EBIT a company generates in relation to its Enterprise Value. The EV is the market capitalization of the company plus net debt (debt - cash). If EV/EBIT ratio is low, a company may be considered undervalued (on this metric), and vice versa.

Important: Using EV/EBIT ratios, investors can compare the valuations of companies without regard to tax bracket or corporate structures.

For example, let’s look at two hypothetical company valuations:

Company A:

• EBIT of \$2.5 million
• Market capitalization of \$20 million
• \$5 million in debt
• \$1 million in cash

Company B:

• EBIT of \$1.1 million
• Market capitalization of \$10 million
• \$6 million in debt
• \$0.5 million in cash

This means that Company A has an EV of \$24 million while Company B has an EV of \$15.5 million. Running the ratios:

• Company A: \$24 million / \$2.5 million = 9.6x
• Company B: \$15.5 million / \$1.1 million = 14.1x

On an EV/EBIT basis alone, Company A looks like it offers better value than Company B.

## EBIT Limitations

Investors should be careful about using EBIT or EV/EBIT ratios in isolation to determine a company’s financial health and valuation appeal. While it gives good insight into the profitability of a firm's business operations, it doesn’t take into consideration the company's capital structure. For instance, even if a company reports strong EBIT numbers, if a company is highly leveraged, it may not be profitable at all once interest is deducted.

Warning: EBIT and EV/EBIT values shouldn't be used in isolation in assessing a company.

## EBIT Alternatives

An investor or business owner can look at some alternative measures to EBIT which may end up providing a different picture of the financial health of the company. Here are some EBIT alternatives and how they compare.

### EBIT vs EBITDA

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The difference between EBIT and EBITDA is that the latter ignores depreciation and amortization expenses. As a result, EBITDA may give a better indication on the cash flow profitability of a firm, since depreciation and amortization do not actually represent cash outflows.

EBITDA = EBIT + Depreciation + Amortization

### Operating Income vs EBIT

EBIT includes operating expenses and non-operating expenses whereas operating income doesn’t include the non-operating expenses. Non-operating expenses can be one-time costs. Operating income takes the gross income and subtracts operating expenses such as COGS and business-related expenses such as selling, general, and administrative expenses (SG&A). Operating income leaves in the non-operating expenses.

Operating Income = Gross Income - Operating Expenses - Depreciation - Amortization

EBIT represents the profit a company is making, while operating income can help identify how much of the company’s revenues can be converted into profit. Operating Income essentially measures how much profit can be expected. While EBIT is commonly used, it is not considered a Generally Accepted Accounting Principles (GAAP) measure. Operating income, meanwhile, is considered a GAAP-approved measure.

For example, consider a company with following income statement:

• Operating income: \$228 million
• Benefit plan income: \$5 million
• Interest expense: (\$58 million)
• Tax expenses: (\$32 million)
• Net Income: \$143 million

We can calculate the EBIT by adding back the interest and taxes to the net income:

EBIT = \$143 million + \$58 million + \$32 million = \$233 million

So while the operating income is \$228 million, the EBIT is \$233 million. Note that the operating income did not include the one-time benefit plan credit since that is a non-operating line item.

### NOI vs EBIT

The net operating income (NOI) is used in real estate to determine the profitability of real estate assets owned for income-generating purposes.

NOI = (Gross Operating Income + Other Income) - Operating Expenses

The difference between NOI and EBIT is that EBIT takes into consideration the depreciation and amortization. This means that EBIT will be lower than NOI because depreciation and amortization are not hard dollars.

For example, assume an apartment building costs \$10 million with \$3 million in operating expenses and \$100,000 in HVAC unit depreciation. The NOI is \$7 million (NOI = \$10,000,000 - \$3,000,000 = \$7,000,000). The EBIT would factor in the depreciations bringing the value down to \$6,900,000. The NOI is a better evaluator of cash flow.

## Bottom Line

EBIT is important whether you are a business owner or an investor seeking to capitalize on a company’s profitability. Investors can use the calculation along with the enterprise value to compare companies and see where your best investments lie.

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Kimberlee brings professional experience to her writing. She started as a FINRA Series 7 broker and later transitioned her career into owning an insurance agency and preparing taxes.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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