What is EBIT?
EBIT, often just referred to as operating income, stands for “Earnings Before Interest and Taxes” and measures a company’s operating profitability in a specific period after COGS and operating expenses are deduced.
- What is the definition of EBIT?
- What does EBIT stand for and which line items are factored into EBIT?
- Why is operating income frequently used for comparisons?
- How is operating income different from EBITDA?
Table of Contents
How to Calculate EBIT
On the income statement, EBIT is the profit metric that takes into account the following:
- Revenue: The net sales generated throughout the period.
- Cost of Goods Sold (COGS): The direct costs incurred in the period (i.e. tied to how revenue is produced).
- Operating Expenses (OpEx): The indirect costs incurred in the period (i.e. not directly tied to revenue generation but integral to business operations).
Written out, the formula for EBIT is as follows:
Operating Income Formula
- EBIT = Gross Profit – Operating Expenses
Operating Income Example Calculation
For example, let’s say that a company in 2021 has the following financials:
- Revenue: $25 million
- COGS: –$10 million
- OpEx: –$5 million
The gross profit is equal to $15 million, from which we deduct $5 million in OpEx to calculate EBIT.
- EBIT = $15 million – $5 million = $10 million
EBIT Margin Example Calculation
Continuing off our previous example, we can divide our company’s EBIT by its revenue to calculate the EBIT margin (i.e. operating margin).
- EBIT Margin = EBIT / Revenue
- EBIT Margin = $10 million / $25 million = 40%
Since comparisons of standalone EBIT amounts are not meaningful, standardization is required, which is the purpose of multiples.
In our example, the EBIT margin is 40% — which means that for each dollar of revenue generated, $0.40 is retained and available for non-operating expenses.
The 40% EBIT margin can be compared against that of comparable peers, as well as with historical margins to evaluate the financial performance of the company in question.
Importance of EBIT (or Operating Income)
The previous calculation of the EBIT margin leads to our next point.
Why? EBIT is unaffected by discretionary decisions, such as:
- Debt Financing (% of Total Capital Structure — Interest Expense)
- Non-Core Income Sources (e.g. Interest Income)
- One-Time Corporate Decisions (e.g. Divestitures, Inventory, or PP&E Write-Downs)
- Taxes (i.e. Jurisdiction Dependent)
All relative valuation is skewed to some extent, but by using an unlevered metric like EBIT, a significant amount of flaws can be avoided.
It is important to note that one of the primary objectives of relative valuation is to compare to the core operations of the comparable companies, as opposed to the non-core operations.
For example, let’s say that there are two companies with net margins of 40% and 20%.
However, the operating margins of the two companies could be much closer, as the cause of the 20% differential might be related to capital structure decisions — i.e. the company with 20% net margins might have undergone an LBO, so incurs substantial interest expense each period.
By comparing the operating margin, these non-core differences are intentionally neglected to facilitate more meaningful comparisons among peer groups.
EBIT vs. EBITDA
To reiterate from earlier, EBIT and EBITDA are two of the most frequently used metrics for peer comparisons.
Like EBIT, EBITDA removes the effect of capital structure decisions and taxes — however, depreciation & amortization is added back since they represent non-cash charges (as well as sometimes stock-based compensation).
EBIT and EBITDA Formula
- EBIT = Gross Profit – Operating Expenses
- EBITDA = EBIT + Depreciation and Amortization (D&A)
EBIT and EBITDA are informative metrics to track a company’s profitability and operational performance.
Hence, both metrics appear in the majority of comps sheets.
EBITDA is typically a larger amount than EBIT because of the non-cash add-backs, with the difference becoming more apparent for capital-intensive industries (i.e. large number of fixed assets + depreciation expenses) — which is an area of frequent criticism.
Another distinction between the two is that operating income (EBIT) is a GAAP metric and appears on the income statement.
On the other hand, EBITDA is a non-GAAP metric and the reconciliation is typically shown separately in SEC filings, as well as used in investor presentations and by equity analysts.
EBIT Calculator — Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
EBIT Example Calculation
Suppose we’re given the 2021 income statement of a company and tasked with calculating its EBIT.
Starting from the company’s $100 million in revenue, the first step is to deduct COGS, which is stated as $40 million.
- Revenue = $100 million
- COGS = $40 million
The gross profit is equal to $60 million, which we calculated by subtracting COGS from revenue.
- Gross Profit = $100 million – $40 million = $60 million
From gross profit, we must now subtract the company’s operating expenses, wherein there are two types recorded.
- SG&A = $15 million
- R&D = $5 million
The total operating expense amounts to $20 million, which we’ll use to reduce gross profit and arrive at an EBIT of $40 million (and a 40% EBIT margin) for our hypothetical company.
- Total Operating Expenses = $15 million + $5 million = $20 million
- EBIT = $60 million – $20 million = $40 million
- EBIT Margin = $40 million / $100 million = 40%