What is EBIT? This is an important indicator in corporate financial reports and analysis. However, this is not a familiar term for those who are not specialized in financial statistics. Let's learn more about EBIT and the method to calculate with Viindoo through the article below.
What is EBIT?
EBIT stands for Earnings Before Interest and Taxes. In finance, EBIT is the profit a business makes from doing business before deducting interest and taxes. When analyzing corporate finance, EBIT should be equal to business capital without deducting interest and taxes.
EBIT stands for Earnings Before Interest and Taxes
EBIT does not deduct these factors from businesses’ earnings:
- I-Interest: This means the interest on debt and directly affects the capital structure of a business.
- T - Taxes: These include the tax expenses of a business.
As these two factors are included, EBIT clearly shows the ability of a business to generate profits, thereby making it easier for analysts to compare companies in the same field.
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How to calculate EBIT in financial statements
Calculating EBIT is simple, mainly applying the following formula:
(1) EBIT = Total Revenue - Operating expenses
However, for financial statements in Vietnam, interest expenses are included in financing costs, making it difficult to determine operating expenses. In this case, use the following formula:
(2) EBIT = Earnings before tax + Interest expense
Note: If the financial statements do not show interest expenses, these expenses can be found in the footnotes to the financial statements.
In case the financial statements do not include interest expenses, apply the following formula:
(3) EBIT = Gross profit – Cost of Goods Sold – Operating Expenses
Note: Equation (3) is only an approximate EBIT formula.
In financial statements in Vietnam, it is difficult to determine operating costs.
Example: Company G sells toy products with a turnover of 100 billion USD. The cost for production and business activities is 35 billion USD. Company G's interest expense is $5 billion, while its pre-tax profit is $60 billion. We can calculate the EBIT as follows:
Option 1: EBIT = 100 – 35 = 65 billion
Option 2: EBIT = 60 + 5 = 65 billion.
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Meaning of EBIT in finance
To choose the best investment option, investors will need to consider a company's ability to generate profits. However, each company has a different capital and tax structure, so it is difficult to compare and analyze the capabilities of each company.
By not deducting debt costs and taxes, investors can get an accurate picture of profitable activities. In addition, EBIT also represents the ability to control costs and return capital to investors of the business.
In addition, EBIT helps investors predict a business's performance and growth potential. Therefore, they can evaluate the ability to recover capital or increase the profits of the business in the future.
Besides, companies can have different tax rates. EBIT makes it easy for investors to compare companies operating in the same industry. This helps investors have a more objective view of the company's performance.
Applications of the EBIT Index
Calculating EBIT Margin
EBIT Margin represents the profit margin before taxes and interest. This ratio is used to look at the efficiency of a business in managing all operating costs, including capital structure and operating expenses.
EBIT Margin helps compare the performance of a business over years. Besides, investors can use this index to compare businesses operating in the same field.
The higher the EBIT Margin of a business, the better the performance of that business, and vice versa. Usually, the ideal EBIT Margin is 15%.
Ebit Margin is calculated by dividing EBIT by Net revenue, which, EBIT is profit before tax and interest, and net revenue is profit after deducting taxes.
EBIT Margin represents the profit margin before taxes and interest are deducted
5-step Dupont Analysis
5-step Dupont Analysis is used by investors to analyze and evaluate the performance of an enterprise. With the model, investors can easily analyze the production capacity, business capacity, as well as debt repayment capacity, and return on capital of a business.
The 5-step Dupont analysis includes:
1. Net revenue/average total assets: This shows the ability of the business to use assets to generate revenue. This helps investors evaluate whether the business is effectively using assets or not. A high index means the business performance is good.
2. Average assets/average equity: This indicator tells about the ability to use and manage the capital of the enterprise. The index directly affects the ROE - Return of Equity.
3. Tax burden: This index tells about the taxes of the business, as well as how the business adjusts to minimize the tax payments.
4. Interest burden: This index shows the debt situation and the ability to control loans of enterprises. Interests greatly influence the risks in the payment and return of capital of a company.
5. Ebit Margin: This metric shows the efficiency of a business in managing all operating expenses.
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Assess Interest Coverage Ratio
To evaluate the ability to pay interest, use the EBIT as follows:
Interest Coverage Ratio = EBIT / Interest expense
Investors can use the EBIT to see if the business is generating enough profit to cover its interest payments. The higher this ratio, the higher the loan repayment and interest potential of the business and vice versa.
In addition, interest payment capacity helps investors assess the financial position and business activities of the enterprise. If a business does not generate enough profit to pay off its loans, it will inevitably default and go bankrupt.
However, the EBIT does not deduct interest payments, thereby affecting investors' judgment about the earnings potential of companies with a large debt. Therefore, investors need to learn carefully about the company's loans before making investment decisions.
The EBIT ratio is used to see if a business is generating enough profit to pay interest
Value stocks
The EBIT index helps value stocks. Although rarely used in Vietnam, this method is actually quite popular with investors around the world. Businesses with an EBIT of more than 10 are considered good, and investors can use this index to compare companies operating in the same industry.
The EV (Enterprise Value) index can also be used for stock valuation. This index has the following formula:
EV = (Stocks price x Number of stocks outstanding) + Minority interest + Short-term and long-term debt + Market value of preferred shares - Cash and cash equivalents.
EBIT/EV < 10 is considered good. However, enterprises with EBIT/EV > 10 are not necessarily in a bad situation because this index may be affected by other factors. Therefore, investors should analyze and evaluate the factors that are likely to affect these indicators.
Calculate EPS
The EPS represents the earnings per stock. Investors often use this ratio to analyze the profit-generating potential of corporate stocks, thereby considering suitable investment options.
The relationship between the EBIT system and EPS is:
EPS = [(EBIT – Debt Interest)(1 – t) – PD]/NS
Or:
EBIT = (EPS x Outstanding ordinary shares) + Preferred dividends Shares / [Debt yield + (1 – Tax rate)].
In which:
- I: Annual interest payable
- t: Corporate income tax rate
- PD: Dividend payable for preferred shares
- NS: Number of shares outstanding.
From the formula, when EBIT increases, EPS also increases, and vice versa. When the EPS is high, the ability to generate profits on stocks is high. Investors can use this index to consider which stocks to buy/sell can provide the best returns.
When the EPS is high, the ability to generate profits on stocks is high.
The efficiency in the use of financial leverage of the enterprise is shown through two indexes EPS and EBIT. Financial leverage is the phenomenon when businesses use debt including stocks to create fixed assets. Investors will appreciate businesses that can generate returns that outweigh the costs of debt.
The content of the above article has provided information to answer the question of what is EBIT as well as the application of EBIT in business financial statements. Viindoo hopes that this information has helped readers better understand EBIT and can apply this index to assess the business performance in the most accurate way.
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