Updated July 14, 2023
Definition of EBIT
EBIT, i.e., earnings before interest and taxes, refers to the earnings of the business before taking into account the interest and the tax payments or other words, EBIT is a measure of any company’s profitability from its normal operations as the EBIT is calculated by deducting the total of operating expenses from the total of sales revenue.
The Formula for EBIT Calculation
EBIT measures the business’s profitability from its operations as it does not consider the expenses relating to interest and taxes. EBIT is also known as the company’s operating income as it shows the company’s earnings from normal business operations, neglecting the effect of the interest and tax expense on the business profits. Two methods can calculate the EBIT of the company. The first method is subtracting all the company’s operating expenses from the sales revenue, and the second one is to add up interest expense and the tax expense in the company’s net income. A formula can be illustrated below:
1. First Method (Direct)
The formula for the Direct Method is:
In this case,
- Revenue during the period is the total amount of revenue earned by the company during the period under consideration by selling the goods or providing the services.
- The cost of the goods sold is the total amount of cost incurred by the company during the period under consideration for the goods it sells or services provided to the customer.
- Operating expenses are the expenses that a company incurs for operating its business.
2. Second Method (Indirect)
The formula for the Indirect Method is:
In this case,
- Net profit is the profit the company earns after deducting interest and taxes during the period under consideration.
- Interest expense is the expense that the company makes during the period on any of its borrowings.
- Tax expense is the expense payable by the company during the period to the tax authority.
Examples of EBIT
Following are the examples are given below:
Example #1
There is a company, XYZ incorporation, in which Sales revenue during the financial year 2019-20, as per the income statement, is $500,000. During the current financial year, the company’s cost of goods sold is $200,000; its operating expense is $100,000. Interest expense is $25,000, tax expense is $20,000, and the net profit is $155,000. Compute the EBIT of the company.
Solution:
In this case, EBIT can be computed during two methods below:
- First Method (Direct)
Earnings Before Interest and Taxes (EBIT) is calculated as
- Earnings before interest and taxes (EBIT) = $500,000 – $200,000 – $100,000
- Earnings before interest and taxes (EBIT) = $200,000
| Particulars | Amount ($) |
| Sales Revenue | 5,00,000 |
| Less: Cost of goods sold | 2,00,000 |
| Less: Operating expense | 1,00,000 |
| Earnings before interest & taxes [EBIT] | 2,00,000 |
- Second Method (Indirect)
Earnings before interest and taxes (EBIT) is calculated as
- Earnings before interest and taxes (EBIT) = $155,000 + $25,000 + $20,000
- Earnings before interest and taxes (EBIT) = $200,000
| Particulars | Amount ($) |
| Net Profit | 1,55,000 |
| Add: Interest Expense | 25,000 |
| Add: Tax Expense | 20,000 |
| Earnings before interest & taxes [EBIT] | 2,00,000 |
So, the company can calculate the operating profit or EBIT using the two methods above.
Example #2
Suppose Tata Inc. has made the following transactions in the financial year ending March 2020.
- The total sales revenue of the company was $1,000,000
- Total Purchases were $550,000
- Opening and closing inventory was $50,000 & $70,000, respectively.
- Salary & wages paid were $150,000
- Rent Paid was $60,000
- Depreciation expenses were $30,000
- Interest expenses were $20,000
- Taxes paid were $30,000
Now calculate EBIT from the above figures.
Solution:
Earnings before interest and taxes (EBIT) = Revenue during the period – Cost of the goods sold– Operating expenses
The cost of The Goods Sold is calculated as
- Cost of The Goods Sold = $50,000 + $550,000 – $70,000
- Cost of The Goods Sold = 530,000
And,
Operating expenses are calculated as
Operating Expenses = Salary & Wages + Rent Paid + Depreciation Expense
- Operating Expenses = $150,000 + $60,000 + $30,000
- Operating Expenses = $240,000
So,
EBIT is calculated as
EBIT = Revenue During the Period – Cost of The Goods Sold– Operating Expenses
- EBIT = $1,000,000 – $530,000 – $240,000
- EBIT = $230,000
| Particulars | Calculation | Amount ($) |
| Sales Revenue | 10,00,000 | |
| Less: Cost of goods sold | ||
| {opening stock[A] | 50,000 | |
| Purchases[B] | 5,50,000 | |
| Closing stock[C]} | 70,000 | |
| COGS[A+B-C] | 5,30,000 | |
| Less: Salary & Wages | 1,50,000 | |
| Less: Rent Paid | 60,000 | |
| Less: Depreciation expense | 30,000 | |
| Earnings before interest & taxes [EBIT] | 2,30,000 |
Thus the company earned EBIT of $230,000 during the current year.
Example #3
Suppose in the above example we are given the information like the following:
| Particulars | Calculation | Amount ($) |
| Sales Revenue | 10,00,000 | |
| Less: Cost of goods sold | ||
| {opening stock[A] | 50,000 | |
| Purchases[B] | 5,50,000 | |
| Closing stock[C]} | 70,000 | |
| COGS[A+B-C] | 5,30,000 | |
| Less: Salary & Wages | 1,50,000 | |
| Less: Rent Paid | 60,000 | |
| Less: Depreciation expense | 30,000 | |
| Less: Interest Expense | 20,000 | |
| Less: Current year Taxes | 30,000 | |
| Net income | 1,80,000 |
And now, we calculate EBIT using the Indirect Method:
Solution:
Calculation of EBIT using Indirect Method:
Earnings Before Interest and Taxes (EBIT) = Net Profit Earned + Interest Expense + Tax Expenses
- EBIT = 1,80,000 + 20,000 + 30,000
- EBIT = 2,30,000
| Particulars | Calculation | Amount ($) |
| Net income | 1,80,000 | |
| Add: Interest Expense | 20,000 | |
| Add: Current year Taxes | 30,000 | |
| Earnings before interest & taxes [EBIT] | 2,30,000 |
Conclusion – EBIT Calculation
Hence, EBIT is the business’s earnings before deducting the interest and the tax expense from the revenues. The measure of EBIT is important to know the business’s financial performance, i.e., how efficiently the company is managing its routine operations to generate revenues. EBIT ignores the cost of finance and the burden of taxes, which are deducted while calculating the company’s net income.
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