What Is EBIT? A Simple Guide for Business Owners

What is EBIT?

Simply put, Earnings Before Interest & Tax.

EBIT is a critical metric used to evaluate a business's performance because it focuses purely on operational profit, excluding variables such as interest and tax. It's commonly used as a baseline reference when comparing business elements like return on capital.

IN THIS ARTICLE:

→ EBIT in the Real-World
→ Interest Doesn't Reflect Business Performance
→ Tax Doesn't Define Business Strength
→ Why EBIT is Essential for Valuation
→ EBIT vs EBITDA
→ How to Improve EBIT
→ EBIT compared to other Metrics
→ How an Outsourced CFO Impacts EBIT

EBIT in the Real-World

• Business A has an EBIT of $1 million, but due to high debt, it incurs $500k in interest, leaving $500k in profit.
• Business B has the same $1 million EBIT but minimal debt, resulting in significantly lower interest payments and higher profit after interest and tax.

The lesson: EBIT shows both businesses operate efficiently, but their financing structures influence their bottom-line results very differently.

Interest Doesn't Reflect Business Performance

Interest expenses can vary widely based on a company's debt structure. Whether a business has a high, low, or no interest expense doesn't necessarily make it more or less successful. If a wealthy investor buys the company or eliminates its debt, the interest disappears, but the core business remains the same.

• A business with no debt is not automatically better than a business with debt.
• Interest expenses should still be covered by earnings, especially if there are banking covenants requiring a specific EBIT-to-interest coverage ratio.

Tax Doesn't Define Business Strength

Just like interest, tax can vary depending on the legal structure of the business. Whether a business is set up as a company, trust, or partnership affects how and where tax is paid.

EBIT allows comparison across businesses regardless of their tax structure, ensuring that tax planning strategies don't distort an understanding of operational profitability.

Why EBIT is Essential for Valuation

EBIT is often the key metric used when valuing a business, as it reflects true operating performance. This is especially relevant when looking at the potential profitability of a business without considering how it's financed or how taxes get managed.

• EBIT focuses on earnings that directly come from business operations.
• It's a reliable metric to understand how well a business is performing compared to others, regardless of its interest or tax situation.
• Investors prefer EBIT because it gives a pure look at operating performance and allows them to compare businesses regardless of how they're financed.

EBIT vs EBITDA

As their names suggest, EBIT (Earnings Before Interest & Tax) includes depreciation and amortisation, whereas EBITDA (Earnings Before Interest, Tax, Depreciation & Amortisation) excludes these non-cash expenses. EBIT provides a more complete picture of a business's profitability because it captures operational performance while considering the wear and tear on assets.

• EBIT is often preferred for analysing operational profitability because it includes the full spectrum of operating expenses, including asset depreciation. EBIT provides a more complete picture of long-term profitability, particularly for capital-intensive business where asset depreciation plays a significant role in costs.
• EBITDA is more focused on cash generation, which can be more useful for short-term liquidity analysis and understanding a company's ability to service its debts. EBITDA is often used for business valuations, especially when comparing companies that have different capital structures or asset depreciation schedules, as it smooths these differences out.

How to Improve EBIT

Key strategies for improving EBIT might include:

• Increase Revenue: By improving sales processes, launching new products, or expanding into new markets.
• Cut Operational Costs: Reduce inefficiencies in production, procurement, or staffing while maintaining quality. 
• Increase Gross Margin: Optimise pricing strategies and supplier negotiations to enhance profitability.

How is EBIT different to Net Profit, Operating Profit and EBITDA

EBIT often gets confused for EBITDA, Net Profit and Operating Profit but is distinctly different from these other metrics.

• EBITDA focuses primarily on operational cash flow as it excludes depreciation and amortisation (the Before Depreciation & Amortisation in EBITDA), which makes it useful for asset heavy industries.
• Net Profit factors in all expenses, including interest and tax (excluded in EBIT), however as a result, will not provide as clear as a picture of operational performance that EBIT provides. This is exaggerated and vital to understand the difference for highly leveraged businesses.
• Operating Profit is often used interchangeably with EBIT, however there are some small, subtle differences between the two based on what can be included. EBIT can sometimes include non-operating income (such as income from property or investments) and may also include non-operating expenses such as gains from asset sales or litigation costs. Operating profit would exclude these.

How an Outsourced CFO Impacts EBIT

By employing an outsourced CFO you can get a significant impact on your EBIT, as they help to enhance both revenue and operating costs. Here's how CFO Dynamics, working as your outsourced CFO could contribute:

1. Revenue Growth Strategies

Outsourced CFO's can provide insights that help grow your top line. These include:

• Pricing Optimisation: Analyse your pricing structure to guarantee you're charging appropriately for your products or services, potentially increasing revenue without incurring costs or making grand operational changes.
• Revenue Stream Diversification: Outsourced CFOs help identify key opportunities to develop new revenue streams and markets, again boosting overall earnings.
• Sales Performance Analysis: CFO Dynamics can help assess your sales data, identifying areas of poor performance, and recommend actions to maximise the revenue from current existing customers and clients.

2. Cost Management and Efficiency Improvements

One of the key central roles of an outsourced CFO is helping to control operational costs without compromising quality, which is directly tied into EBIT. This can be achieved through:

• Cost-cutting initiatives: As Your outsourced CFO, CFO Dynamics can identify areas for cost reduction. In the past we have renegotiated supplier contracts and reduced waste in production processes to help improve profitability.
• Process Efficiency: Through the optimisation of operational workflows, a CFO should make the business run smoother and more efficient, reducing unnecessary expenses.
• Expense Review: They can scrutinise your overheads and direct costs, helping you reduce unnecessary expenditures or allocate resources more effectively.

3. Gross Margin Enhancement

Improving your gross margin is a direct lever for improving EBIT. An Outsourced CFO can:

• Optimise Supply Chains: By finding more cost-effective suppliers or renegotiating better terms, a CFO can reduce the cost of goods sold (COGS), increasing gross margin.
• Product Mix Strategy: They can analyse your product or service mix, focusing on higher-margin offerings, which will allow for an improvement in profitability without increasing overall operational complexity.

4. Budgeting and Forecasting

By helping with accurate budgeting and forecasting, a CFO can help drive better decision making by:

• Setting Realistic Targets: With a thorough understanding of your operational costs and revenue, they can help set accurate and achievable EBIT goals.
• Scenario Analysis: A CFO can run different financial scenarios (best, worst, and best case) to assess the impact of various decisions on your EBIT, ensuring you are prepared for market changes.

5. Strategic Decision-Making

EBIT at its core is a reflection of operational efficiency - An outsourced CFO will play a critical role in improving decision making:

• Investment Analysis: Help make smarter decisions about capital expenditure, with the experience to ensure investments improve earnings, not drag down your EBIT. 
• Profitability Analysis: A CFO can conduct regular profitability analyses of all aspects of your business, regardless of unit, project, or product - you can just focus on the most profitable areas of your business.

6. Debt Management

While EBIT excludes interest, an outsourced CFO can still help manage your debt efficiently so you can run your business knowing you have a healthy operation without over leveraging:

• Interest Optimisation: A CFO can help ensure you only pay the interest that is necessary through the optimisation of your debt structure.
• Cash Flow Management: They make sure you hold enough cash to cover operational needs whilst still covering debt obligations appropriately, guaranteeing a strong EBIT performance.

If you still need help understanding your EBIT, or want us to take care of any EBIT concerns you may have please contact us! We want businesses to succeed, just give us the chance.

Learn everything we teach our clients... for free

Join 400+ business owners & leaders who receive practical business & accounting tips, delivered free to your inbox every week. No fluff, just high-level expertise. Sign up now.