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What is EBIT? How to calculate it and use it for your business?
So, wondering what EBIT is. Is it the same as EBITDA? In this article, we’re going to break this down for you, show how EBIT can be calculated and how you can use it to better manage your business's financial health.
Let’s go!
What is EBIT?
EBIT is an acronym for Earnings Before Interest and Taxes. It’s a measure of a business's profitability based on revenue minus costs but with the exclusion of interest and tax expenses.
EBIT is not the new cryptocurrency you should invest in! It is one of many ways you can assess the profitability of your business!
It’s a measure of your company's performance in its normal business operations. It’s the metric that is the closest to your core business!
How much did you bring in? and how much did it take to do so! Pretty easy, right?
Why is EBIT important for my business?
Calculating your EBIT demonstrates how your business is performing on its own. It oversimplifies the financial logic in order for you to analyse how your business activities are fundamentally behaving.
EBIT is a margin, hence a percentage. This percentage allows you to assess your own business performance, of course! But it also, and very importantly, allows you to compare yourself to others in the same industry!
The simple nature and comparability of EBIT provides a crystal clear view on how profitable your business really is. This shows investors, banks and other lenders your core business has earning potential!
So that’s awesome, and pretty straightforward, for sure! But how exactly do you calculate your EBIT?
How do you calculate EBIT?
If you’ve read our other insanely insightful (if I may say so myself) articles on profitability metrics, you’ll know that there are often several ways to get the same result! EBIT is no exception!
EBIT can be calculated using either revenue or net income.
EBIT = NET INCOME + INTEREST + TAXES
Or
EBIT = Revenue - COST OF GOODS (or service) SOLD - OPERATING EXPENSES
Ok, you have your EBIT margin. What now and what does it mean?
How is EBIT used in business?
Now that you have your EBIT, the goal is to put it to use! There are some common thresholds for EBIT:
- A margin below 3% is considered to be not profitable (boo!)
- A margin from 3% to 9% is considered viable (meh)
- A margin above 9% means your company has good earning potential (woohoo!)
But you should compare yourself to your competitors! What makes a good or great EBIT margin depends heavily on what industry or sector you operate!
An EBIT margin shouldn’t be set in stone. If your goal is to improve EBIT,there are several ways to do so! If your supplier's fees are increasing, it will bring your EBIT down. Maybe time to revise your prices, eh!
EBIT or EBITDA?
EBIT is not the most accurate metric if your company has a big chunk of fixed assets! Fancy offices? Company car fleet? Brand new pizza ovens and appliances to run your business? These things lose value over time and influence your actual profitability!
It is called Depreciation and Amortisation and has its own metric called EBITDA ‘Earnings Before Interest, Taxes Depreciation and Amortisation). And yes, we did write an article about it so you can calculate both and see what fits your financial management!
Interview with Thierry Veil Co-founder, Bagelstein
How to explain EBIT to a young entrepreneur?
The interest of the EBIT: showing the most refined results on the performance of a company.
EBIT is quite simple to understand and to calculate, but in several steps!
First of all, we start from the turnover! We remove a first level of expenses and we find ourselves with one of the first interesting indicators: the gross margin. That said gross margin will then cover the expenses. From rent to salaries, insurance and electricity… What is left is your net result.
But it is difficult to make sense out of, because it is distorted by many parameters. The first thing that pollutes the result is taxes! Because it does not fully reflect what happened during the past year.
Example: You have a tax credit. The amount will not be proportional to what your company has generated during the year.
The same goes for financial expenses! Borrowing is a method of financing that is not related to operations. It therefore also pollutes the reading of your performance!
How should a more mature business understand EBIT?
To give you an example, at Bagelstein, we have a monthly follow-up of the EBIT per store. Our places have very different realities! Some use bank financing for example, so the interest must be deducted. Others benefit from tax credits after a loss of activity during the COVID crisis!
The EBIT allows to remove these random data and clarifies drastically the comparison between several shops. As a business leader, a result as clear as "sales, minus purchases & direct expenses" is a very powerful and meaningful indicator.
EBIT VS EBITDA: Which one to choose?
Measuring both is the best eh! But it is the nature of the business that will define which is more useful or relevant. Depending on how it is financed, and the resources needed for your activity!
If you invest in very expensive machinery, or to pay for a substantial business: you will not see it in the EBITDA, but it will be highlighted by the EBIT.
EBIT is therefore a complete performance indicator, and takes into account the realities of businesses with heavy material assets!
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As we saw, there are many ways to track your results in order to manage your finances better, EBIT is one of many ways! But in today’s intricate and fast-moving business world, SME leaders can’t allow themselves to be extracting data and filling spreadsheets and screaming at your accounting software!
Too much time wasted. too much margin for error.
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