BREAKING DOWN 'Earnings Before Interest & Tax - EBIT'

Earnings Before Interest and Taxes (EBIT) measures the profit a company generates from its operations, making it synonymous with "operating profit." By ignoring tax and interest expenses, it focuses solely on a company's ability to generate earnings from operations, ignoring variables such as the tax burden and capital structure.

This focus makes EBIT an especially useful metric for certain applications. For example, if an investor is thinking of buying a firm out, the existing capital structure is less important than the company's earning potential. Similarly, if an investor is comparing companies in a given industry that operate in different tax environments and have different strategies for financing themselves, tax and interest expenses would distract from the core question: how effectively do these companies generate profits from their operations?

There are different ways to go about calculating EBIT, which is not a GAAP​ metric and therefore not usually included in financial statements. Always begin with total revenue (or equivalently, total sales) and subtract operating expenses, including the cost of goods sold. You may take out one-time or extraordinary items, such as the revenue from the sale of an asset or the cost of a lawsuit, as these do not relate to the business' core operations, but these may also be included. If a company has non-operating income, such as income from investments, this may be—but does not have to be—included; in that case, EBIT is distinct from operating income, which, as the name implies, does not include non-operating income.

Often, interest income is included in Earnings Before Interest & Taxes, but it may be excluded depending on its source. If the company extends credit to its customers as an integral part of its business, then this interest income is a component of operating income and is always included. If, on the other hand, the interest income derives from bond investments, or charging fees to customers that pay their bills late, it may be excluded. As with the other adjustments mentioned, this one is up to the investor's discretion, and should be applied consistently to all companies being compared.

In the simplest terms, EBIT is calculated by taking the net income figure from the income statement and adding the income tax expense and interest expense back in. Put a different way, operating expenses are subtracted from total revenue. As an example, we'll use Procter & Gamble Co's (PG) income statement from the year ending June 30, 2016 (all figures in millions of USD):

Net sales

65,299

Cost of products sold

32,909

Gross profit

32,390

Selling, general and administrative expense

18,949

Operating income

13,441

Interest expense

579

Interest income

182

Other non-operating income, net

325

Earnings from continuing operations before income taxes

13,369

Income taxes on continuing operations

3,342

Net earnings (loss) from discontinued operations

577

Net earnings

10,604

Less: net earnings attributable to non-controlling interests

96

Net earnings attributable to Procter & Gamble

10,508

To calculate EBIT, we subtract the Cost of Goods Sold (COGS) and the Selling, General and Administrative (SGA) expense from the Net Sales. We then add Non-Operating Income and Interest Income to obtain an EBIT of:

For the fiscal year ended 2015, P&G had a Venezuelan charge. Whether to include the Venezuela charge raises questions. As mentioned above, one-time expenses can arguably be excluded. In this case, a note in the 2015 earnings release explained that the company was continuing to operate in the country though subsidiaries. Due to capital controls in effect at the time, however, P&G was taking a one-time hit to remove Venezuelan assets and liabilities from its balance sheet.

Similarly, an argument could be made for excluding interest income and other non-operating income from the equation. These considerations are to some extent subjective, but consistent criteria should be applied to all companies being compared.

Another way to calculate P&G's fiscal 2015 Earnings Before Interest & Taxes is to work from the bottom up, beginning with the Net Earnings. We ignore non-controlling interests, as we're only concerned with the company's operations, and subtract the Net Earnings from Discontinued Operations for much the same reason. We then add Income Taxes and Interest Expense back in, to obtain the same EBIT we did via the top-down method: