EBIT Calculation

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. In this topic, we are going to learn about EBIT Calculation.

The formula for EBIT Calculation

EBIT is the measure of calculating the profitability of the business 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 the normal business operations neglecting the effect of the interest and tax expense on the business profits. The EBIT of the company can be calculated by two methods where the first method is subtracting of all the operating expenses of the company from the sales revenue and the second one is to add up interest expense and the tax expense in the net income of the company. A formula can be illustrated as below:

1. First Method (Direct)

The formula for the Direct Method are:

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 sold or service is provided to the customer.
• Operating expenses are the expenses which a company incurs for operating its business.

2. Second Method (Indirect)

The formula for the Indirect Method are:

In this case,

• Net profit is the profit earned by the company after deducting interest and taxes during the period under consideration.
• Interest expense is the expense which is payable by the company during the period on any of its borrowings.
• Tax expense is the expense which is 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 case of 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; 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 as below:

•  First Method (Direct)

Earnings Before Interest and Taxes (EBIT) is calculated as

Earnings Before Interest and Taxes (EBIT) = Revenue During the Period – Cost of The Goods Sold– Operating Expenses

• Earnings before interest and taxes (EBIT) = $500,000 – $200,000 – $100,000
• Earnings before interest and taxes (EBIT) = $200,000

• Second Method (Indirect)

Earnings before interest and taxes (EBIT) is calculated as

Earnings before interest and taxes (EBIT) = Net Profit Earned +interest Expense + Tax Expenses

• Earnings before interest and taxes (EBIT) = $155,000 + $25,000 + $20,000
• Earnings before interest and taxes (EBIT) = $200,000

So, the company can calculate the operating profit or EBIT using any of the two methods given above.

Example #2

Suppose a company named Tata Inc. has made the following transactions in the financial year ending on 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

Cost of The Goods Sold is calculated as

Cost of The Goods Sold = Opening Stock + Purchases – Closing Stock

• 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 calculates as

EBIT = Revenue During the Period – Cost of The Goods Sold– Operating Expenses

• EBIT = $1,000,000 – $530,000 – $240,000
• EBIT = $230,000

Thus the company earned EBIT of $230,000 during the current year.

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Example #3

Suppose in the above example we are given the information like the following:

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

Conclusion – EBIT Calculation

Hence, EBIT is the earnings of the business 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 is deducted while calculating the company’s net income.

Recommended Articles

This is a guide to EBIT Calculation. Here we also discuss the definition and examples of EBIT along with a detailed explanation. You may also have a look at the following articles to learn more –

1. Estimated Tax
2. Times Interest Earned Ratio
3. Interest vs Dividend
4. EBITDA vs Operating Income
5. Adjusted EBITDA