In this article, you will learn about one of the most important aspect while reading and making a decision on a particular’s company financial report.
And that is what you will learn from this article that is about “What is EBIT?”
For every small or large business or company, they have to maintain a close towards knowing their profits.
For measuring the profitability of a company there are many metrics, but Earnings before Interest and Tax is the most common tool.
What is EBIT in Finance?
EBIT stands for Earnings before Interest and Taxes.
Earnings before interest and taxes is a measurement of your company’s profitability.
It enables you to calculate your revenue, minus expenses (including interest and tax).
In some cases, you’ll find that earnings before interest and taxes is also referred to as operating earnings, profit before interest and taxes, or operating profit.
Formula of EBIT
The EBIT Formula can be computed into two ways:
1. Direct Method
The Direct Method of calculating EBIT Formula is by Subtracting the cost of goods and operating expenses from total revenue.
EBIT = Total Revenue – COGS – Operating Expenses
2. Indirect Method
The indirect method starts with net income and backs out interest expense and taxes.
EBIT = Net Income + Interest + Taxes
As you can see, it’s a pretty simple calculation using either method, but it’s important to understand the concept of what EBIT is.
The first formula shows us directly what is taken out of earnings, while the second equation shows us what must be added back into net income.
This is an important distinction because it allows you to understand the ratio from two different points of view.
The first is more of a preliminary operations point of view.
The second is more of a year-end profitability point of view.
Obviously, both equations arrive at the same number.
Why is EBIT important for your business?
EBIT provides you with a measure of your company’s profitability from operations.
Because it doesn’t take into account the expenses associated with taxes and interest, EBIT ignores variables like capital structure and tax burden.
There are a couple of key areas where EBIT is especially handy:
Taxes – It’s particularly useful for investors who are comparing different companies with different tax obligations.
For example, a company that has recently received a tax break may appear to be more profitable than one that hasn’t, but this may not be the case.
Measuring earnings before interest and taxes can help clarify the situation.
Debt – Furthermore, EBIT can be very useful when analyzing businesses in capital-intensive industries.
These types of companies may have numerous fixed assets on their balance sheets (usually financed by debt), which means that they have high-interest expenses.
However, as these fixed assets are important for long-term growth, it helps to have a measure of profitability that strips out debt and its associated expenses.
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