EBIT: A Measure of a Company’s Operating Performance and Efficiency
EBIT, also known as operating income or operating profit, is a measure of a company’s profitability that focuses on its operating performance before considering the impact of interest expenses and income taxes. It is calculated by subtracting a company’s operating expenses (including cost of goods sold, selling and administrative expenses, and other operating costs) from its total revenue. The formula for EBIT is:
EBIT = Total Revenue – Operating Expenses
EBIT provides insights into how well a company’s core operations are performing, without taking into account the effects of its financing decisions (interest expenses) and tax obligations.
EBIT & EBITDA limitations
The relevance of EBIT and EBITDA metrics varies significantly based on the specific industries under consideration.
EBIT proves to be a more pertinent indicator of operational efficiency within sectors that have highly capital intensive industries such as Manufacturing, Infrastructure, Oil & Gas, Mining. In contrast, it holds less significance within the Service sector. The reason is highly capital intensive industry adds back lot of D&A expenses distorting it.
Conversely, EBITDA finds its greater utility within industries characterized by minimal capital expenditure requirements to sustain their operations. In such contexts, EBITDA emerges as a valuable gauge for assessing cash flow.
By employing EBIT and EBITDA metrics to compare companies operating within the same industry, we can discern those that encountered operational challenges in the past from those that excelled. Through this analysis, we can subsequently delve into qualitative aspects to identify the underlying factors contributing to these performance disparities.