EBIT is an acronym derived from Earnings Before Interest and Taxes. It provides a way to measure how profitable a business is over a specific period of time, usually one year. The calculation to determine EBIT is:
EBIT = Operating Revenue – Operating Expenses (excluding tax and interest payments)
Commonly referred to as Operating Profit or Operating Income, EBIT focuses on the ability of a business to generate profit based on ongoing operations.
Operating revenue is money earned by a business from regular operations and does not include changes in inventory value or non-recurring sources of income. Operating Expenses refer to transactions generated by the everyday operations of a business and would not include expenses from discontinued or non-recurring activities.
There are many financial reports which provide information about a business and most are based on the generally accepted accounting principles (GAAP) of the United States. EBIT is a non-GAAP financial calculation which offers an alternative way to look at business transactions. Non-GAAP classification does not indicate the practice is illegal or inaccurate; however, it does allow for more flexibility in what is and is not included in the calculation.
Business owners will need to look at the Profit & Loss Report or Income Statement to find the dollar amounts necessary to complete the EBIT calculation.
Using this example, EBIT is $21,070.00 (non-recurring income excluded) and Net Income (including interest and tax expenses) is $13,480.25.
From an investor’s point of view, EBIT levels the playing field and allows an apples-to-apples comparison between businesses with different tax structures and different financing methods within the same industry. This makes it easier to see how profitable a business is, regardless of their tax structure or interest payments on loans or other debt.
However, a business owner may be more interested in Net Income than EBIT, since that calculation includes all sources of income and expenses, providing a more complete financial picture.
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Post updated from 9/12/2012 to include examples and related material.