Earning Before Interest and Tax in English, often abbreviated as EBIT, is a measure of a company's ability to make profits from operations without considering interest expenses and tax expenses. The value is very close to free cash flow (Free Cash Flow). Typically, there are two ways to calculate EBIT: The first one: Subtract the cost of sales (COGS) and operating expenses (Operating Expense) from total revenue (Revenue), and the calculation result is equivalent to operating profit (Operating Profit); Second: If the company's net profit comes from operating activities (no other income/expenses), then interest expenses and tax expenses can also be added to the net profit to obtain EBIT. Earnings before interest and taxes are particularly suitable for evaluating capital-intensive companies, because the capital of such companies is usually obtained through debt, and interest is required to repay debt. Taking interest expenses into account in the company's operating income can provide a more complete assessment of the actual profitability of such companies. It should be noted that if non-recurring charges appear on the company's financial statements, such as corporate restructuring costs, litigation costs, asset impairment, etc., these non-recurring charges need to be calculated in the profit before interest and tax. EBIT = operating profit + non-recurring expenses Second: If the company's net profits come from operating activities, then interest expenses and tax expenses can be added to the company's net profits, that is: EBIT = Net Profit + Interest Expense + Tax Expense Among them: Net Profit (Net Profit) refers to the company's total revenue minus the cost of sales, general and administrative expenses, operating expenses, depreciation and amortization, interest, taxes and other expenses, etc.; Interest Expense refers to the interest paid by the company on commercial loans used to maintain business operations; Tax Expense refers to the taxes that a company must pay on its profits during operations in accordance with U.S. law; The values required for the above calculations can be found in the income statement and other income/expense statements in the company's financial reports. Earnings before interest and tax calculation example This chapter will perform example calculations using Apple’s September 2023 financial report: We can obtain operating profit from the income statement in AAPL's financial report. Values of items in the income statement (September 30, 202) Operating Income$114,301 million AAPL Income Statement (September 2023) So, EBIT = Operating Profit = $114,301 million What investment guidance does EBIT have? Earnings before interest and taxes indicate the profitability of the company's core business and are not affected by the company's loan interest and corporate taxes. The main use value of EBIT is that it avoids the impact of non-operating expenses such as taxes and interest expenses, thereby considering a company's core operating capabilities. When comparing companies in the same industry with different debt situations, using earnings before interest and taxes is the most effective measurement indicator. Especially for companies that rely on debt to create profits, using earnings before interest and taxes can more fairly assess the value of the company. At the same time, EBIT is also very suitable for measuring the profitability of companies with different tax situations. For example, one company enjoys tax benefits and another does not. When using earnings before interest and taxes, this situation can be well avoided in measuring the company's profitability. Earnings before interest and taxes are also very suitable for evaluating the profitability of asset-intensive companies, because asset-intensive companies usually need to use debt financing to prepare assets, such as oil companies, natural gas companies, etc. Because this type of company holds a large amount of debt, it needs to pay a large amount of interest. When using net income to measure the company's value, it is impossible to consider the company's profits through debt. Therefore, when using EBIT to analyze, it can more completely analyze the company's operating capabilities and profit potential.
Below, we use an example to explain the usage scenario of EBIT. For example, the net income of Company A and Company B is $1,000,000 and $800,000 respectively, while the interest expense of the two companies is $50,000 and $400,000 respectively. Net profit (A) = $1,000,000 Net profit (B) = $800,000 Consider interest expense: EBIT (A) = $1,050,000 EBIT (B) = $1,200,000 When comparing using net income, Company A is more profitable. But if interest expenses are added to net profit, Company B's profitability is higher. What are the limitations of using EBIT? EBIT is not a standard indicator of generally accepted accounting principles, so there are no strict industry standards when calculating it. Different companies may adjust the calculation method according to their needs, which may lead to different EBIT values. EBIT has deducted depreciation and amortization. Therefore, when using EBIT to evaluate two companies with huge differences in fixed assets, it may not be possible to fully compare their profitability. In addition, different industries have different cost structures, capital intensity and tax policies, so EBIT may not be completely comparable and may be misleading when compared across industries. What indicators are earnings before interest and taxes mainly used for? EBIT is often used in calculations: Interest Coverage Ratio and EBIT/EV multiple. interest coverage ratio Interest Coverage Ratio, often abbreviated as ICR, measures the ratio of earnings before interest and taxes to interest expenses. The interest coverage ratio is used to evaluate whether the company's profits can cover its interest expenses. The higher the ratio, the better the repayment ability. The lower the ratio, the worse the interest repayment ability. It is generally believed that an interest coverage ratio of more than ten times is an important indicator of a company's financial stability. EV/EBIT multiple The EBIT/EV multiple calculates the ratio of enterprise value to earnings before interest and taxes. It is used to measure the company's operational efficiency and profitability. It is similar to the enterprise value multiple and can be used to value listed companies.