The acronym EBIT is short for "earnings before interest and taxes." In general, EBIT is the amount that is left over once the cost of goods and operating expenses are subtracted from a firm's revenue. Although interest paid and taxes are of vital concern to a business, they are not operating expenses and are thus excluded.
The formula for calculating the EBIT margin is EBIT divided by net revenue.
Overview of EBIT
The earnings before interest and taxes for a given accounting period is the amount of money that remains after the cost of goods and all operating expenses are subtracted from net revenue. An EBIT margin is the EBIT amount divided by the net revenues and is expressed as a percentage. This is a straightforward series of calculations. It is also easy to locate the required information since all of the figures are reported on a firm's income statement at the end of each accounting period.
EBIT and EBIT margin are essentially measures of how well a business manages its operations. This is why capital costs, usually meaning interest expenses, and taxes are excluded. Since interest and taxes are not operating expenses and are subtracted after EBIT is determined on the income statement, they don't impact operating efficiency.
Calculating the EBIT Metric
Calculating the EBIT margin is a two-step process. First, you must calculate earnings before interest and taxes. Look on the firm's income statement for the year or other accounting period. The first item listed is the company's gross revenues. Any discounts, returns or other allowances are subtracted from gross revenues to determine net revenues.
Next, the cost of goods sold is subtracted. The category below the cost of goods sold is the firm's operating expenses. This category includes a variety of items that are usually grouped into three subcategories: selling expenses, general costs and administrative expenses. Each of these items must be subtracted from the amount remaining after the previous calculation.
Once you have finished subtracting all of these items from the starting amount, you've arrived at the earnings before interest and taxes. Keep in mind that the income statement does not end here. It continues on to report the interest and tax amounts that are not included in EBIT.
Suppose the ABC Company generates $1 million for the year in gross sales or revenues. You subtract discounts, returns and adjustments that total $20,000, leaving $980,000. The cost of goods sold is listed at $600,000. After subtracting the cost of goods sold, $380,000 remains. Next, subtract the selling costs, general costs and administrative expenses. In this example, these total $200,000. What you have left is $180,000. This is the business's EBIT for the accounting period.
How to Calculate the EBIT Margin
The formula for calculating the EBIT margin is EBIT divided by net revenue. Multiply by 100 to express the margin as a percentage. Be sure to use the net revenues listed near the beginning of the income statement, not the gross sales or revenue. Suppose the EBIT for the AABC Company was $180,000 for the year, and net revenue was $980,000. Divide $180,000 by $980,000 and multiply the result by 100. The EBIT margin in this example works out to about 18.4 percent.
Importance of the EBIT Margin
The EBIT and associated margin are not figures required by generally accepted accounting figures. However, the EBIT margin is very useful as a means of comparing the operating efficiency of a company from one year to the next or to compare the firm's operating efficiency to other businesses in the same industry.
When you are looking at the EBIT margin for the current year as compared to earlier years, you want to see a percentage that is equal to or greater than that of the previous year. The same is true when comparing the firm's EBIT margin to that of another company. A lower EBIT may indicate problems with the business's operating efficiency.