What is EBIT?

The full form of EBIT is Earnings Before Interest and Taxes. It is basically a part of financial accounting. It is a measure used to determine the true profitability of the firm. The true or actual profitability of a company can be calculated because this measure does not include the interest and tax paid by the company. It gives the amount of profits actually earned by the company. EBIT is the sum of operating income and non operating income.

On the other hand, operating income is operating revenue minus operating expenses. But in some cases, the operating income is equal to EBIT. This happens only when the firm has no non operating income. This is a very important measure. This is because it shows the repaying capacity of a company. It shows the amount of cash that the company can use in order to pay back the creditors. EBIT is also used as a tool of comparison. This way one can compare the growth of different firms over a period of time. 

Another reason why EBIT is used by investors to judge the profitability of the firm is that every company has a different tax structure and different financial policies. Thus tax and interest hide the true operational efficiency of the company. And comparison becomes difficult as well. In this case, EBIT is a great tool for determining the operational efficiency of a company. But one must not completely rely on the EBIT. This is because a company which appears highly profitable by calculating EBIT may not be actually profiting due some high interest rate on a huge unpaid debt or debts. Also if the company has poor investment strategies and if they do not have many tax deductible investments then again the profitability is affected.

Investors use EBIT in order to decide which company to invest in. a company which is more profitable may not be most efficient. And a company which is more efficient may not be more profitable. This way an investor gets an opportunity to compare and contrast the financial position of various companies in which the investor is planning to invest.

There is another measure known as EBITDA. The full form of EBITDA is Earnings Before Tax Interest Depreciation and Amortization. The difference between EBIT and EBITDA is that in EBITDA earnings are taken before charging depreciation and amortization whereas in EBIT the depreciation and amortization has already been charged. Depreciation and amortization are not cash items but they do play a role in estimating the capital expenditure of a company. EBITDA just focuses on profitability of the company. It fully ignores the investment part which is in fact responsible for the profitability. Therefore, some investors may consider may consider EBIT as a better tool as compared to EBITDA as it gives a better and more realistic view of the profits earned by a company. A true picture of the financial position can be made with the use of EBIT.