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Earnings before interest and taxes

From Wikipedia, the free encyclopedia

In accounting and finance, earnings before interest and taxes (EBIT) is a measure of a firm's profit that includes all incomes and expenses (operating and non-operating) except interest expenses and income tax expenses.[1][2]

Operating income and operating profit are sometimes used as a synonym for EBIT when a firm does not have non-operating income and non-operating expenses.[3]

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  • EBIT and EBITDA explained simply
  • EBIT or Earnings Before Interest & Taxes
  • What is EBIT? | Earnings Before Interest & Taxes (EBIT) | EBIT or Earnings Before Interest & Taxes

Transcription

Welcome to the "Finance Storyteller" series. I am here to make business strategy and finance enjoyable and easier to understand. In this video we are going to cover the financial terms EBIT and EBITDA. Let me give you some context, so you know where EBIT and EBITDA fit in. There are three financial statements: The balance sheet, an overview what we own and what we owe at a point in time. The income statement, an overview of the profit or income that you generate during a period. And... The cash flow statement, an overview of how much cash you generate, and where you spend your cash during a period. EBIT and EBITDA are income statement metrics. EBIT is Earnings Before Interest and Taxes. EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization Earnings is the same as income or profit. The word "before" suggests that we are excluding certain items from our operational performance metric. Interest is excluded, as it depends on your financing structure. How much did you borrow, and at what interest rate? Taxes are excluded, because it depends on the geographies that you work in. Depreciation and amortization are sometimes excluded, because they depend on the historical investment decisions that a company has made, not the current operating performance. Let me show you an overview of an income statement, or profit and loss statement, so you know where EBITDA and EBIT fit in. Revenue minus Cost Of Sales equals Gross Profit. Gross Profit minus S,G&A and R&D equals EBITDA. EBITDA minus Depreciation & Amortization equals EBIT. EBIT minus Interest and Taxes equals Net Income. Please be aware that different companies use different terminology, so what you see here might be different from what your company is using. Also, not every company reports both on EBITDA as well as EBIT. EBITDA is commonly used as a metric in very capital-intensive industries like manufacturing, trucking, oil and gas, and telecom. Service-heavy industries like consultancy wouldn't even bother splitting out the two. What is depreciation? How does that work? Let's assume you want to buy a truck for your company to deliver your products. You spend $100,000 to buy it. What happens on your financial statements is that cash goes down by $100,000, and your fixed assets (or "plant and equipment") go up by $100,000. It would be incorrect to book the full $100,000 straight away as a cost for the current year, because you are going to use the truck for multiple years. That's when depreciation comes up. Let's assume that the truck has a useful economic life of 5 years, and has no residual value. If you use straight-line depreciation, you book $20,000 per year in depreciation. The value of the asset on the balance sheet goes down by $20,000 per year, and in the income statement you charge this $20,000 as an expense. Let's look at an example of using EBIT and EBITDA in financial reporting. I took the 2015 annual report of the Maersk Group, a company headquartered in Denmark and operating globally. They report in US$. Their best known business is Maersk Line, which is the world's largest container shipping company. They are also active in areas like oil and gas, terminals and drilling. Maersk's revenue in 2015 was 15% lower than the year before, and net income (or net profit) was down by 82%. But is net income the most relevant way to measure their profitability performance? Maersk gives you the choice to also evaluate profitability at other levels: EBIT was down 68%, and EBITDA was down 24%. Depreciation and amortization are sometimes referred to as "fixed costs", they don't go up and down with the number of units that you sell, but they are driven by the investments that you have made, and the number of years you use those assets. In the case of a company like Maersk, which operates in a capital intensive industry, depreciation is a huge number, 8 billion USD in 2015, almost 20% of revenue. Looking at the EBITDA as well as the EBIT performance gives you more information than looking at EBIT alone. What do business and finance people use EBITDA for? It is often mentioned as part of M&A (or Mergers & Acquisitions) news. A quick-and-dirty way to calculate the value of a company is by using a multiple of EBITDA. This can help you to get to a ballpark number, but I would advise to always do a more thorough analysis and a more thorough valuation of a company, as there are a lot of "ifs" connected to using an EBITDA multiple: you are assuming the profitability and the industry does not change, you exclude the impact of working capital (which could go up dramatically for a fast-growing company), and you exclude the cash that you need for capital expenditures on an ongoing basis for the company. In summary: what is EBIT and EBITDA? EBIT is Earnings Before Interest and Taxes EBITDA is Earnings Before Interest, Taxes, Depreciation and Amortization. Both EBIT and EBITDA are measures of profitability, along with terms like gross profit and net income. EBITDA is a meaningful metric for capital-intensive industries. I hope you have enjoyed this "Finance Storyteller" video! Thank you for watching! Please let me know what you think in the comment section, and connect on my blog, Linked In, Twitter or YouTube.

Contents

Formula

EBIT = Net income + Interest + Taxes = EBITDA – Depreciation and Amortization expenses
Operating income = operating revenueoperating expenses (OPEX) = EBIT – non-operating profit + non-operating expenses[3]

Overview

A professional investor contemplating a change to the capital structure of a firm (e.g., through a leveraged buyout) first evaluates a firm's fundamental earnings potential (reflected by earnings before interest, taxes, depreciation and amortization (EBITDA) and EBIT), and then determines the optimal use of debt vs. equity.

To calculate EBIT, expenses (e.g. the cost of goods sold, selling and administrative expenses) are subtracted from revenues.[4] Net income is later obtained by subtracting interest and taxes from the result.

Example statement of income (figures in thousands)[5]
Revenue
     Sales revenue $20,438
     Cost of goods sold $7,943
Gross profit $12,495
Operating expenses
     Selling, general and administrative expenses $8,172
     Depreciation and amortization $960
     Other expenses $138
     Total operating expenses $9,270
Operating profit $3,225
     Non-operating income $130
Earnings before Interest and taxes (EBIT) $3,355
     Financial income $45
Income before interest expense (IBIE) $3,400
     Financial expense $190
Earnings before income taxes (EBT) $3,210
     Income taxes $1,027
Net income $2,138

Earnings before taxes

Earnings before taxes (EBT) is the money retained by the firm before deducting the money to be paid for taxes. EBT includes the money paid for interest. Thus, it can be calculated by subtracting the interest from EBIT (earnings before interest and taxes).

See also

References

  1. ^ Bodie, Z., Kane, A. and Marcus, A. J. Essentials of Investments, McGraw Hill Irwin, 2004, p. 452. ISBN 0-07-251077-3
  2. ^ "Earnings before interest and, taxes (EBIT) definition".
  3. ^ a b "How are EBIT and operating income different?".
  4. ^ http://www.investorwords.com/1631/EBIT.html EBIT definition
  5. ^ Bodie, Z., Kane, A. and Marcus, A. J. Essentials of Investments, McGraw Hill Irwin, 2004, p. 452.
This page was last edited on 20 November 2018, at 09:30
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