EARNINGS BEFORE INTERESTS AND TAXES (EBIT)

Meaning of EBIT

Earnings before interest and taxes is a metric that shows how profitable a company is. The earnings before interest and taxes can be calculated by subtracting total business expenses (however, with the exception of taxes and interest) from the total revenue generated. Several kinds of literature often refer to earnings before interest and taxes as operating profit or profit before interest and taxes. The business operating cost that is usually subtracted from the revenue to give the earnings before interest and taxes comprise of manufacturing cost, cost of raw materials, cost of machinery as well as wages of employees.

With the exception of taxes and interests, the earnings before interests and taxes considers the ability of a business to generate income from just its operation. It is therefore important for organizations to use this EBIT metric to know if the business is generating enough profit to sustain the organization and not incurring losses.

Formula: Rev.= total revenue generated, and operating cost covers manufacturing cost, cost of running machineries, employee salaries, and more.

Relationship between earnings before interests and taxes and debt

The EBIT is applicable in the analysis of capital intensive businesses. Capital intensive businesses are organizations whose balance sheet contains a large number of fixed assets (that is, physical properties, machineries, industrial plants and so on). The large number of these fixed assets is an avenue for these capital intensive ventures to incur great debts that often leads to high-interest expenses. In this case, the major relationship between the EBIT and debt is that potential investors will use the metric to analyze the operating performance of the company, and at the same time separating debt and other expenses.

Relationship between earnings before interests and taxes and taxes

In a case where investors are tasked with comparing the tax situations of a number of organizations, the EBIT becomes a very useful metric. It gives the investors more insight into the operational profit of the organization, without the tax ratio being the center of the analysis. In addition, when businesses within the same industries, however with different tax rates are to be analyzed, the EBIT becomes a useful metric. 

Applications of EBIT

·        The EBIT is used to calculate the profitability of businesses. The total operational cost of the business (including manufacturing cost, staff wages and so on) is subtracted from the total revenue to get the  EBIT value.

·       The EBIT is used by investors in decision making. As an investor, making a profit is part of the plan. In order to know just how the operation of a business is, without being concerned about the debt and interest ratio of the company, the EBIT becomes suitable for use.

Shortcomings of the EBIT

·        Depreciation is considered when calculating the EBIT. With depreciation being considered, varying outcomes would be gotten when different companies are being compared. The capital intensive companies are the most hit because the depreciation of the fixed assets often results in a lower net income for the company.

·        The EBIT metric does not take into consideration the interests a company has to pay due to debt incurred. This often leads to inflated earning potentials for such companies.