EBIT: Strips Out How the Company Is Financed
EBIT is earnings before interest and tax, arrived at by adding interest and tax back to net income. Removing both makes two companies comparable on operations alone, and it means a heavily indebted company and a debt-free one can show the same figure.
How it works
Start at net income. Add back the tax charge. Add back the interest expense. What you have is earnings before interest and tax, and the acronym is the whole definition.
It is usually the same number as operating income, and not always. Operating income is built downward from revenue and excludes non-operating items by definition; this is built upward from net income and therefore includes anything non-operating that sat above the interest line — investment income, a gain on an asset sale.
On most companies the gap is trivial. On a company with meaningful investment income it is not, and the two figures being used interchangeably is the source of a good deal of confusion.
What removing interest actually does
Two companies running identical operations can be financed completely differently. One funded itself with shareholders’ money and pays no interest; the other borrowed and pays a great deal. This figure makes them comparable.
And they are not the same investment. Identical operations, identical earnings before interest, and one of them owes a great deal of money. The comparison this figure enables is a real one and it answers a narrower question than most people use it for.
Tax is the second thing removed, for the same reason. A company’s effective rate depends on where it operates and how it is structured, neither of which describes the business.
In practice
As a percentage of revenue it becomes a margin that compares across companies with different balance sheets, which is the form used in most valuation work.
It is also the numerator of interest cover — this figure divided by interest expense — which is one of the most-used solvency ratios. Cover of six times means operating earnings could fall a long way before interest became unpayable; cover of one and a half means it could not.
That ratio is where the excluded interest comes back into the analysis, and it is the reason removing it from the profit figure is not the same as ignoring it.
Depreciation is still inside it, which is the important difference from EBITDA. Assets wear out and have to be replaced, and this figure still accounts for that.
The flattery is worth stating plainly. A company that borrowed heavily to buy assets shows the earnings those assets produce and none of the cost of the borrowing. Used to compare operations that is correct; used to assess the investment it is incomplete.
And acting on the conclusion costs a spread, plus any commission, on each round trip.
A number shows what interest cover is protecting against. A company earns 150 before interest and tax and pays 25 of interest: cover is six times. Operating earnings could fall by 80% before the interest bill became unpayable. Now take a company with the same 150 and 100 of interest: cover is one and a half times, and a 35% fall in earnings takes it to the point where interest consumes everything.
Both companies report 150 on this line. The measure that makes them comparable on operations is the same measure that hides the difference that decides which one survives a bad year — which is why this figure and interest cover are read together rather than separately, and why a valuation built on the first without the second is incomplete by construction.
What EBIT is not
It is not profit available to shareholders. Interest and tax are real payments.
It is not always operating income, though it usually is.
It is not a cash measure. Depreciation is subtracted; working capital is absent entirely.
And it is not a defined line on most income statements. It is a calculation, which means different sources can produce slightly different values for the same company.
How this connects
Its building blocks are the upper lines of the income statement. Revenue minus cost of goods sold gives gross margin, and subtracting operating expenses, including SG&A, brings you close to this figure.
Interest cover is the income version of a debt service coverage ratio, which goes further by including principal repayments as well as interest.
The debt-to-equity ratio tells you why interest differs between two companies, and this figure strips that difference out.
A change in the interest rate hits net income and leaves this line untouched, which is exactly why lenders watch cover rather than profit when rates rise.
Credit analysts lean on it heavily. Weak cover is one of the clearest signs of credit risk, and a company whose cover keeps falling is paying more on each new corporate bond long before any default.
Valuation work often starts from it. A discounted cash flow model begins with operating earnings, adjusts for tax, investment and working capital, and discounts what remains.
The figures come from the 10-K or annual report, where interest and tax are shown separately enough to add back.
And none of it becomes retained earnings until interest and tax are paid.
When it fails
The failure is using it as a profit figure rather than a comparison tool. Interest is paid in cash, on schedule, and a company whose interest bill exceeds what it earns is in trouble regardless of how good this number looks.
The second failure is treating it as interchangeable with operating income when the company has material non-operating items.
A third is comparing it across capital-intensive and asset-light businesses, where the depreciation still inside it means very different things.
A fourth is using it without interest cover. The figure removes financing; the ratio puts it back. One without the other is half the analysis.
And a fifth is accepting an adjusted version. Companies present adjusted figures with their own definitions, and the adjustments are chosen by the party being measured.
The original data
Of the 24,971 trading and investing videos in this site’s corpus, “valuation” returns 8 videos at a median of 160,764 views; “fundamental analysis” returns 49 at a median of 7,377; the relative strength index (“RSI”) returns 594 at a median of 5,377. No video is counted twice, however many searches surfaced it.
Eight videos on valuation in a corpus of 24,971, earning about thirty times the median views of the 594 on one oscillator. That ratio recurs across every fundamentals term measured here, and the direction is consistent: the subjects with almost no supply outperform the subjects with enormous supply, per video. Whatever that says about content, for a reader it means the vocabulary needed to compare two companies on operations alone is not something the material will teach by accident — and interest cover, the ratio that puts the excluded financing back, is the specific thing worth learning alongside this figure.
Related
Operating income is the nearly identical measure built from the other direction. EBITDA adds depreciation back on top. And income statement is the sequence all three come from.
This figure treats debt as though it were free. That is right when comparing two operations and wrong when deciding which company survives a bad year, and those are two different questions to keep apart rather than answer with one number.
— Michael Whitman
This page is educational, not financial advice. Test every idea on your own charts before risking money.