EBIT stands for Earnings Before Interest and Taxes and is used by stock analysts to value and compare companies. In short, the EBIT shows how profitable a company is from an operational standpoint, or from the day to day running of its business.
Some analysts prefer EBIT to the net profit figure, which we analysed last week. That’s because EBIT doesn’t give a hoot about a company’s ability to slice its tax bill or source clever tax advantages to boost its earnings; it doesn’t care less about how a company might fund its operations using sophisticated capital structures; EBIT just cares about how profitable the company is in running the business.
A comparison of the EBIT of two companies will demonstrate which company receives a better margin on its sales.
Some analysts criticise EBIT because it doesn’t take into account leverage, or debt. A company may boost its earnings by taking on scary levels of debt, involving big interest payments each month. Since EBIT excludes interest payments, investors are none the wiser. Similarly, a company may be actually losing money after tax, but this won’t show up in the EBIT figure.
Therefore EBIT shouldn’t be used in isolation, but simply as a tool to evaluate and compare the operating profit of companies. Take a look at both a company’s EBIT and its net profit, even comparing these figures against its peers. You may find that even though one company is more profitable operationally, boasting a higher EBIT, it falls down when tax and interest are taken into account.