Learn how to calculate EBIT with CalcoPolis.
Table of Contents
- What is EBIT?
- EBIT Formula
- How to calculate EBIT?
- Applications of EBIT
- EBIT can be used to evaluate a company's profitability
- EBIT may be used to compare companies
- Profitability metrics that use EBIT
- Limitations of EBIT
- Depreciation and amortization
- Example EBIT calculation
- How to find EBIT?
What is EBIT?
Earnings Before Interest and Taxes is a fundamental metric of company profitability. It's widely used due to its simplicity and accuracy. It can usually be found on a company's income statement and could be referred to as operating profit, operating income, or profit before interest and taxes.
To calculate EBIT, you must subtract operating expenses from the company's revenue. Income tax and interest should not be deducted, as the name suggests.
- EBIT can also be called operating profit
- EBIT gives information about the company's earnings
- Income taxes and interests do not impact EBIT
There are two methods for calculating EBIT value.
EBIT can be calculated by subtracting costs of goods sold (COGS) and other operating expenses from the revenue.
EBIT = revenue - COGS - operation_expenses
Other methods can be derived directly from the definition. Since EBIT is the equivalent of earnings before interest and taxes, you can find EBIT by adding interest and taxes to the net income. So EBIT equation may look like this:
EBIT = net_income + interest + taxes
How to calculate EBIT?
Once we know the formula for EBIT, let's analyze a simple example of some hypothetical retail company.
Step 1. Find the total revenue on the income statement.
Each company presents such information at the end of every fiscal year.
Step 2. Subtract the costs of goods sold.
In the case of retail companies, COGS is simply the purchase costs of all products the company sold in a given period.
Step 3. Subtract the operating profits
Operating profits may include employee salaries, rental costs, advertising expenses, etc. It's important to remember to skip interests and tax expenses.
Applications of EBIT
Earnings Before Interest and Taxes is a simple yet handy indicator that carries much helpful information. Experienced investors use it as a part of their analysis.
EBIT can be used to evaluate a company's profitability
EBIT is a market standard for analyzing the profitability of enterprises with a focus on the efficiency of their operating activities. Companies may use debt as leverage for growth, and interest payments may decrease their current net income. For such companies, net income analysis may undermine the profitability of day-to-day business operations.
Since the interest payments are temporary and after they are paid off, the company may expect an increase in net income - EBIT gives a better overview of the company's current performance.
EBIT may be used to compare companies
Every company may have a different strategy. Some focus on rapid growth using debt, while others grow organically.
What's more, companies may operate in different environments. For example, foreign tax jurisdictions may have different interest rate levels.
By omitting income taxes and interests from business analysis, EBIT allows comparison of the operational efficiency of the companies from different countries where tax rates and interest rates may vary.
Moreover, some companies may have better net income due to tax optimization and not because of better utilization of the available resources. In such cases, comparing EBIT values may reveal which company has higher operating efficiency and is under better management.
Profitability metrics that use EBIT
Earnings Before Interest and Taxes carries a lot of helpful information. However, a business analysis will not be complete if you focus solely on one metric.
Limitations of EBIT
Although EBIT has its advantages, it has its limits too. Understanding EBIT constraints allow us to avoid mistakes and drive to the wrong conclusions. Below we describe a few aspects that need to be considered while analyzing the company's financial statement.
As we mentioned earlier, omitting the interest expense by the EBIT allows a better overview of companies operating efficiency. However, if the management was over-indebted or the interest rates went sharply up, the debt may limit the company's growth, cash flow, and profitability. In such cases relying solely on EBIT may be misleading.
Depreciation and amortization
Companies with many fixed asset depreciation expenses negatively impact the net income. For such companies, comparisons with companies with different situations by just analyzing EBIT will not reveal helpful information.
Since taxes are not part of the EBIT equation, comparison of companies that are under different tax jurisdictions with high differences in tax rates is difficult too. Tax rates don't change often, and if they are too high, they may permanently undermine a company's efficiency in opposition to those with low tax obligations. Companies with higher EBIT may permanently bring lower net profits.
Example EBIT calculation
How to find EBIT?
In order to better illustrate how to calculate EBIT, let's perform the real-life calculation. Below we will calculate the earnings before interest and taxes of Tesla Inc. for the fiscal year 2021. The data for the analysis is from the income statement (source).
|All values in millions||2021|
|Cost of Goods Sold (COGS) incl. D&A||$40,217|
|COGS excluding D&A||$37,306|
|Depreciation & Amortization Expense||$2,911|
|SG&A Expense (operation expenses)||$7,110|
Let’s put the following data into the EBIT formula.
EBIT = revenue - COGS - operation_expenses = $53,823 - $40,217 - $7,110 = $6,496
EBIT of Tesla Inc. (TSLA) for fiscal year 2021 equals $6,496,000,000. Notice that EBIT is always lower than gross income and higher than net income.