EBIT is an acronym that stands for Earnings Before Interest and Taxes. It is generally used to calculate a company's ability to earn a profit, and the larger the value, the more profitable a company is likely to be. As the name indicates, interest and income tax expenses are not included in the calculation, leaving the focus on company profits. Calculating a company's EBIT value allows a person to see where a particular business stands in comparison to others in the same industry and to directly compare the profitability of two or more companies.
A company's EBIT value is found by subtracting the company's expenses, not including interest or income tax, from its revenue from the same time period — often a fiscal year. It is calculated with this formula:EBIT = Revenue - Operating Expenses
In many cases, the resulting value is the same as the company's operating profit, if the company does not have non-operating income. The simplicity of this calculation makes it a popular tool for giving a general look at a company's profitability.
It is quite common for investors to use this equation when comparing two or more companies because it provides insight into each company's profitability in relatively simple terms. Business A might not have as much revenue as Business B, but if Business A's expenses are lower, the EBIT value might show it to be the more profitable of the two. An investor can use the equation to determine which company is the most efficient and profitable, which company is a good investment choice, and whether or not a company can become more profitable.
There are a variety of benefits that this calculation affords, including the ability to compare companies that have different tax and financial structures. By eliminating tax and interest, different accounting techniques are less likely to adversely affect a more equitable comparison of companies. This allows an investor to better understand how efficiently each company operates and to determine which is the most profitable, despite any structural or procedural differences.
Using this calculation also allows an investor to look at long-term versus short-term investments with different companies. For example, it is possible to figure out which company makes better use of its resources and earns a higher long-term profit on its sales. By looking at earnings before and after interest and tax expenses, investors can also determine which company earns a higher profit due to its financial arrangement or taxation rate, making it more profitable for short-term investments.
EBIT was the springboard for a more in-depth calculation called Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). In addition to interest and taxes, EBITDA removes depreciation and amortization from the calculation. Depreciation is an expense in which the value of an asset is reduced over time; amortization is similar, but involves the paying off of a debt or intangible asset over time. This calculation provides a general idea of a company's cash flow, or, more accurately, its profitability. It is also used to compare two or more companies, but gives more detailed information than the original formula.
Disadvantages and Alternatives
While EBIT is helpful in many cases, it should not be the only tool used when evaluating companies. The simplicity of the calculation makes it easy to use but may lead to inaccurate information. For example, even though a company may appear profitable when using only this value, in some cases the company may actually be losing money because the calculation only looks at recurring expenses, not those that are unusual or one-time. A seemingly promising company may be a poor investment choice if only the EBIT number is considered. Other things to look at include EBIDA, EBITD, operating profit alone, and return on total assets (ROTA).
The acronym could also refer to electron beam ion trap, a device commonly used in physics.