What is Earnings Before Interest and Taxes (EBIT): A Guide

Have you ever wondered how top Malaysian companies like Telekom Malaysia continue to grow their revenues and profits, increasing at RM8.66 billion? One key metric they track is EBIT, which helps measure how well a company performs without the noise of taxes and interest costs.

EBIT represents a company’s profit from its core operations, excluding interest and tax expenses. Simply put, this earning measures a company’s performance and profitability. However, many people may still be unfamiliar with its meaning and how to calculate it.

In line with this, this article will discuss what EBIT is, its benefits, and how to calculate it in financial statements. You will learn the simplest way to compute earnings effectively, and we’ll guide you through easy steps to understand the concept better.

What is EBIT?

EBIT, short for Earnings Before Interest and Taxes, is a key subtotal in the income statement just before net income. Also known as operating income, it’s calculated by subtracting all operating expenses (both production and non-production costs) from sales revenue.

To determine the operating margin, divide operating income by sales revenue, resulting in a percentage (e.g., 10% operating margin). This margin can be compared to the company’s historical margins, current net profit and gross margins, or the margins of industry peers.

Depending on the industry, a company may include interest income in EBIT. If interest comes from customer credit, it’s part of operating income, while interest from bond investments might be excluded.

What EBIT Tells Investors and Analysts

EBIT is helpful for comparing the performance of companies within the same industry but is less effective across different sectors. This is because industries like manufacturing have higher costs of goods sold (COGS) compared to service-based businesses.

Investors rely on this metric to assess a company’s operations without the impact of taxes or capital structure expenses. It also helps standardize comparisons between companies with varying tax rates.

Meanwhile, analysts use EBIT in key financial ratios, such as the interest coverage ratio (this metric divided by interest expenses) and the EV/EBIT multiple, which compares earnings to enterprise value.

Difference between EBIT and EBITDA

EBIT represents a company’s operating profit, excluding interest expenses and taxes. On the other hand, EBITDA, which stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, goes a step further by also excluding depreciation and amortization expenses.

While both exclude taxes and interest, EBITDA provides a clearer view of operational profitability by removing non-cash expenses related to assets.

The key difference lies in how they treat asset-related costs. Companies with substantial fixed assets incur depreciation to spread the cost of these assets over their useful life, which reduces reported profits.

EBITDA ignores depreciation while offering insight into a company’s core operating performance without considering the impact of long-term asset investments.

Why are Earnings Before Interest and Taxes Important for Business?

Investors rely on Earnings Before Interest and Taxes (EBIT) for two main reasons: (1) it’s simple to calculate and (2) it allows easy comparison between companies.

1. Simplicity: EBIT is easy to determine from the income statement, especially when using accounting software, as net income, interest, and taxes are clearly listed.
2. Comparability: The metric adjusts earnings by excluding the effects of a company’s capital structure (adding back interest expenses) and its tax environment. The idea is that a business owner could, in theory, change the company’s capital structure or relocate to a region with a different tax system.

While these assumptions may not always be practical, they are theoretically possible, making EBIT a useful tool for comparison. Using revenue recognition software can further improve the accuracy of reported earnings, ensuring consistency when comparing financial performance across different companies.

However, there’s always a drawback to every method. One of such drawbacks of using EBIT is that it includes depreciation, which can make comparisons between companies in different industries unfair.

For example, a company with lots of fixed assets will have higher depreciation costs than a company with fewer assets. This reduces its EBIT, making it look less profitable even if both companies perform similarly.

To get a fairer comparison, analysts often use EBITDA, which removes depreciation and shows a clearer picture of each company’s actual operating profit.

How to Calculate EBIT

EBIT is calculated by combining a company’s production costs, such as raw materials, with total operating expenses, including employee salaries. These costs are deducted from revenue as follows:

1. Start with the revenue or sales figure listed at the top of the income statement.
2. Deduct the cost of goods sold (COGS) from revenue to get the gross profit.
3. Subtract operating expenses from the gross profit to arrive at EBIT.

Alternatively, companies can calculate Earnings Before Interest and Taxes (EBIT) in two ways. The first method starts with EBITDA, then subtracts depreciation and amortization.

The second method, used when EBITDA isn’t available, involves subtracting SG&A expenses (excluding interest but including depreciation) from gross profit.

Here are the two EBIT formulas:

EBIT = Net Income + Interest + Taxes
EBIT = EBITDA – Depreciation and Amortization

The first formula is simpler because net income, interest, and taxes are always listed on the income statement. In contrast, depreciation and amortization might only appear on the cash flow statement for some companies.

Examples of EBIT Calculation

ABC Manufacturing Sdn Bhd reported a revenue of MYR 1,000,000, a cost of goods sold of MYR 400,000, and operating expenses of MYR 200,000. The company also recorded depreciation and amortization of MYR 50,000, interest expenses of MYR 30,000, and taxes of MYR 40,000.

Let’s break it down in two ways:

Financial Details (in MYR):

• Revenue: 1,000,000
• Cost of Goods Sold (COGS): 400,000
• Operating Expenses (including SG&A): 200,000
• Depreciation and Amortization: 50,000
• Interest Expense: 30,000
• Taxes: 40,000
• Net Income: 280,000

1. Calculation Using Net Income:

EBIT = Net Income + Interest + Taxes = 280,000 + 30,000 + 40,000 = 350,000

2. Calculation Using EBITDA:

First, find EBITDA:
EBITDA = EBIT + Depreciation and Amortization
Rearranged:
EBIT = EBITDA – Depreciation and Amortization

EBITDA = 350,000 (EBIT) + 50,000 (Depreciation) = 400,000
Now:
EBIT = 400,000 – 50,000 = 350,000

Both methods give the same EBIT of MYR 350,000.

Accurate EBIT Calculation with HashMicro Accounting Software

Did you know that you no longer need to calculate EBIT manually these days?

HashMicro’s accounting software is a smart solution now favored by many Malaysian entrepreneurs. Its powerful system performance and user-friendly UI/UX make HashMicro’s EBIT feature a top choice for mid-to-large businesses.

With over 2,000 customers across Southeast Asia, HashMicro offers numerous benefits to Malaysian businesses. These include free demos, unlimited user access at no extra cost, extensive customization, and flexible features that can grow with your company over time.

Here are HashMicro’s top features to boost your business productivity:

• Financial Ratios: Automatically calculates key financial ratios like liquidity, profitability, and debt ratios.
• Multi-Level Analytics: Provides real-time insights into financial transactions, filtered by categories such as projects or branches.
• Profit & Loss Reports: Highlights deviations between estimated and actual profits based on budgeted values.
• Cash Flow Reports: Tracks cash inflows and outflows to maintain liquidity, support financial planning, and identify potential issues early.
• Budget Forecasting: Predicts future budgets using historical data to help with resource allocation and strategic decision-making.

Conclusion

Although EBIT, also known as the net profit before tax formula, is a useful metric, a thorough financial analysis is crucial to get a complete picture of a company’s financial health, including its interest and debt commitments.

To make this process easier, HashMicro’s accounting software can help you generate financial reports like cash flow and income statements while managing business operations such as inventory and taxes. Try a free demo today to explore an easier path to financial stability!

Frequently Asked Questions on Earnings Before Income and Taxes

• How does operating income differ from net income?

  Operating income (EBIT) shows profit from a company’s main business activities, without including interest and taxes. Net income is the final profit after deducting all expenses, including interest, taxes, and other costs.

• Can operating profit be negative, and what does it indicate?

  Yes, operating profit can be negative. This means the company’s main business isn’t earning enough to cover its operating costs, which could signal poor cost management or low sales.

• How is profit before interest and taxes used in company valuation?

  Profit before interest and taxes is used to compare companies’ performance through valuation ratios like EV/EBIT. This helps investors see how profitable a company is without being affected by debt levels or tax rates.

• Is operating earnings the same as gross profit?

  No, they’re different. Gross profit is revenue minus the cost of goods sold (COGS), focusing on production costs. Operating earnings (EBIT) subtracts all operating expenses from gross profit, showing the overall profit from business operations.