EBIT or Earnings Before Interest and Taxes is a metric to find out how profitable a business is.
EBIT is calculated by subtracting the expenses from the company's revenue. The trick to this calculation is to exclude interest and taxes from the expenses. This tells you how much profit you can generate by removing the variables from the net income.
Also, the exemption allows EBIT to be calculated for any period irrespective of the interest & tax time periods. This in turn allows EBIT of two companies to be compared.
An investor can use the EBIT statistic to judge whether the company has the potential of generating real earnings. Thus, they can decide on whether to invest in the company.
EBITDA is a variation of EBIT and excludes Depreciation and Amortization in addition to Interests & taxes.
EBIT calculation starts with the gross profit. Operating costs such as Costs of goods sold (COGS) are subtracted from the gross profit. Any expenses incurred to raise business capital and tax liabilities is excluded from the calculation. This direct method of calculating EBIT is used for accounting.
EBIT = `r - c - e`
Earnings before interest and taxes can also be calculated using the alternate formula which utilizes net profit. This is the indirect method and is also referred to as financial EBIT.
EBIT = `p + i + t`
The direct method tells you how much is taken out of earnings. While the indirect method tells you how much should be added back to the net income. No matter which approach you use, the resultant EBIT should be the same.
Let's consider Maxotek, a software company. It's yearly income statement is as follows:-
|Costs of goods sold||$30,000|
|Total operating expenses||($20,000)|
|Interests & Taxes|
|Total interest and taxes||($70,000)|
Using the above to calculate EBIT:-