KPI of the Day – Accounting: $ Earnings Before Interest and Taxes (EBIT)
Definition
Measures the company’s operating income, i.e. the income resulted from the company’s primary business operations. Interest and taxes are excluded, because they include the effect of factors other than the profitability of operations.
Purpose
To reflect a company’s earning power from ongoing operations.
Recommendations
The concept of Value-Based Management emerged as a counterpart to the growing criticism of traditional accounting measures. By additionally taking into account the opportunity cost of the capital employed, economic profit started to replace the rigid old format of accounting profit. The notions of alignment and long-term value creation began to resonate better with corporate strategy planning.
The transition from traditional profit calculation to EVA-based profit calculation was made with the preservation of $ Earnings before interest and taxes (EBIT) as part of the calculation method. As a result, investors and shareholders have become particularly interested in this profitability indicator.
EBIT can provide investment analysts with useful information for evaluating a company’s operating performance without regard to interest expenses or tax rates. This indicator also helps minimize these two variables that may be unique from company to company, and enables one to analyze operating profitability as a singular measure of performance.
However, there are a few considerations to analyze before deciding to make an investment decision solely based on $ EBIT results:
- $ EBIT is a non-standardized pre-tax indicator;
- The decision to include or not to include financial income and non-interest expense into the calculation of $ EBIT, belongs to each company reporting on this indicator;
- Some companies’ reports on $ EBIT exclude non-operational income and expenses from the calculation;
- Analyzing $ Revenue alongside $ EBIT can provide indication of whether non-operating revenues are included in the calculation.
Certain entities may be tempted to only report on $ EBIT to consolidate their position within the investment community. Having $ EBIT is a non-GAAP financial measure, it is recommended for it to be drawn back to an adequate GAAP measure, such as $ Net profit. During meetings, both investors and shareholders should consider whether $ EBIT is properly balanced and reported on.
One last factor to keep in mind is that it is not a precise indicator of net profit, as a company with a good EBIT, but high interest and tax expenses, can have a rather modest bottom line.
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