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From bleeding edge startups to global juggernauts, every business needs to keep a close eye on their profitability. If you don’t, your cash flow can dry up and your business may run into problems. There are a broad range of metrics that are used to measure profitability, but earnings before interest and taxes is probably the most common. Find out everything you need to know, including how to calculate earnings before interest and taxes.
What is EBIT in finance?
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.
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 analysing 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.
EBIT versus EBITDA
There are numerous metrics you can use to analyse the profitability of a business. Aside from EBIT, EBITDA (earnings before interest, taxes, depreciation, and amortization) is another widely used formula. In addition to interest and taxes, EBITDA removes debt financing, depreciation, and amortization from the equation. This helps businesses gain a better sense of the profitability of their operational performance.
Often, EBIT and EBITDA will show completely different results when calculating the profitability of businesses. This is because depreciation and amortization can add a significant amount to a company’s profits. Because depreciation isn’t shown in EBITDA, it may provide a distorted understanding of profitability for businesses with large numbers of fixed assets (as these businesses are likely to have significant depreciation expenses).
EBIT and EBITDA formula
It’s relatively easy to calculate earnings before interest and taxes, although you’ll need to know a few key pieces of information, including revenue and operating expenses. The earnings before interest and taxes formula is as follows:
So, learning how to calculate earnings before interest and taxes is relatively straightforward. First off, you simply need to take your revenue/sales and subtract the cost of goods sold. This provides you with your gross profit. Then, you subtract the operating expenses from your gross profit, and you’ll have your company’s EBIT figure.
EBIT and EBITDA formulas differ slightly, as they’re measurements of different things. To calculate earnings before interest, taxes, depreciation, and amortization, you can use the following formula:
Earnings before interest and tax example
Here’s a real world example for how to calculate earnings before interest and taxes. Imagine a technology company has a net sales figure of £100,000, a cost of goods sold of £49,000, and an operating income of £12,000. You can use the earnings before interest and taxes formula to work out the technology company’s EBIT:
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