Earnings Before Interest and Taxes: How to Calculate EBIT

EBIT—an acronym for “earnings before interest and taxes”—is a measure of a company's profitability based on its core operations. This metric discloses a company's net income before the deduction of any interest and income tax expenses. EBIT is not part of the U.S. Generally Accepted Accounting Principles (GAAP), which means companies are not legally required to include EBIT on their income statements.

Learn the importance of each part of the EBIT calculation:

1. 1. Earnings: A company's earnings is the amount of income generated after subtracting operating expenses from total revenue.
2. 2. Interest: It's common for a company with many fixed assets on their balance sheets to finance those assets by debt, which requires that the company make interest payments. EBIT does not deduct interest from earnings, which makes it easier to compare different companies that have varying capital structures and interest expenses.
3. 3. Taxes: The EBIT calculation does not deduct taxes from earnings because tax expenses do not necessarily reflect the performance of a business. For example, tax rates vary depending on a company's location.

To calculate EBIT, begin with your company's net income (also called net profit, net earnings, or bottom line) and then add back interest and tax expenses per the following EBIT formula:

EBIT = Net Income + Interest + Taxes

Alternatively, there's a second EBIT formula you may also use:

EBIT = Revenue - COGS - Operating Expenses

In the second formula, revenue represents the total amount of money earned from product sales, COGS represents the cost of goods sold—such as raw materials, equipment, employee labor, and shipping—and operating expenses represent costs like rent, marketing, insurance, corporate salaries, and equipment.

Since subtracting COGS from revenue equals a company's gross profit, you could simplify the second formula even further:

EBIT = Gross Profit - Operating Expenses

While the terms “operating profit” and “EBIT” (earnings before interest and taxes) are often used interchangeably, a company's EBIT technically includes non-operating income—any income from activities not related to its core business operations, such as income generated by selling assets or through investments in other companies. If a business does not have non-operating income, its operating profit and EBIT will be the same.

Like EBIT, EBITDA (earnings before interest, taxes, depreciation, and amortization) does not deduct interest and income tax expenses from a company's net income. The key difference between the two is that EBIT deducts depreciation and amortization expenses, and EBITDA metric does not. Both depreciation and amortization reflect a company's past investments rather than present-day operating profitability. Depreciation expenses measure the loss in value of tangible assets, like vehicles, land, and equipment. Amortization expenses measure the loss in value of intangible assets, like patents, trademarks, and copyrights.

EBIT does not factor in interest expenses, so the metric will exaggerate a company's earnings potential if that company owes a large amount of debt. A company might seem to have high cash flow based on EBIT alone, but in reality that cash might be to pay interest expenses.
Depreciation expenses are another drawback: A company that owns a large amount of fixed assets may receive a lower present-day valuation in comparison to another company due to the depreciated value of fixed assets.

There are different metrics you can use to track your company's profits and compose your company's financial statements:

1. 1. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. This metric indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
2. 2. Net income: Calculate the net income metric by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net income over time is a great indicator of how well or poorly its management team runs the company.
3. 3. Gross profit margin: This financial ratio is the percentage of revenue generated that's greater than the COGS. To calculate gross profit margin, divide gross income by revenue and multiply the result by 100.
4. 4. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate net profit margin, divide your net income by total revenue and multiply the answer by 100.
5. 5. EBITDA: This metric—which stands for earnings before interest, taxes, depreciation, and amortization—calculates a company’s operating performance by excluding all expenses that do not factor into the ongoing operations.
6. 6. EBIT: To calculate earnings before interest and taxes, subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. A company’s EBIT is the same as its operating profit if the company does not have any non-operating income.

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