EBIT: The operating result

In order to make a mean­ing­ful judgement about a company, you depend on key figures that enable you to carry out a (also in­ter­na­tion­al) com­par­is­on. An economic indicator capable of this is EBIT. But before you work with this indicator, you should un­der­stand exactly what it reveals, and how to calculate it.

The EBIT formula is often used in annual reports in English-speaking countries, and in the USA it is used alongside US GAAP (United States Generally Accepted Ac­count­ing Prin­ciples). This key figure is used to evaluate the result of operating activ­it­ies, without including revenues and expenses from taxes and interest. In other words, net income for the year is adjusted for taxes and interest. This value therefore does not cor­res­pond to the actual net result achieved at the end and which increases or decreases the company's assets, but only to an – albeit not un­im­port­ant – pre­lim­in­ary result.

However, the exact in­ter­pret­a­tion of the term EBIT is neither in­ter­na­tion­ally uniform nor clearly defined. The items that are included differ from case to case, so this requires further ex­plan­a­tion.

As long as you are aware of these lim­it­a­tions, however, you can use EBIT to compare companies – not least across national borders. Since taxes vary from country to country, the ratio is a useful indicator for comparing business per­form­ance. Es­pe­cially since interest income and expenses usually have nothing to do with the actual business activ­it­ies of an in­dus­tri­al company, for example, and therefore con­trib­ute little to the eval­u­ation of the operating result.

The EBIT cal­cu­la­tion differs from what you’ll be used to from the income statement. However, it can form the basis for the cal­cu­la­tion, since the key figure also appears in the income statement as an in­ter­me­di­ate step. Therefore, EBIT can be cal­cu­lated either according to the total cost method or according to the cost-of-sales method. Both methods deliver EBIT based on sales revenue.

According to the total cost method:

According to the cost-of-sales method:

Another method of cal­cu­lat­ing EBIT is based on net profit (or net loss). From this amount, you can calculate back because it already contains taxes and interest. This variant is – as you can quickly see – much simpler. In addition, you have to calculate the annual net profit for your balance sheet.

With this procedure, you must therefore deduct the interest and taxes that you already paid or received.

In our example, there are two different companies from different countries and with different financial situ­ations. For the sake of sim­pli­city, they both calculate their EBIT using the same procedure and can therefore be compared. While company A made a net profit of one million pounds for the year, company B made 1.1 million pounds. Company A lives in a state with a high tax rate and therefore has to pay £200,000 in income tax. To finance this, the company took out a loan of £500,000 and has to pay 5% interest on it, i.e. £25,000 per year.

The state in which company B is located charges only £120,000 in income taxes. In addition, this company is financed by a loan of £200,000 at the same interest rate and holds £100,000 in another company that earns it £5,000 in interest. This results in interest costs of £5,000.

Company A

Company B

Although Company B was therefore able to record a higher net profit for the year, the EBIT for the two companies is exactly the same. Only the different taxes and different financing ar­range­ments result in different annual net profits. In terms of EBIT, both companies were equally suc­cess­ful.