EBIT (earnings before interest and taxes) is a company's net income before interest expense, and income tax expense have been deducted. EBIT is often considered synonymous with operating income, although there are exceptions. Investors and creditors use EBIT to analyze the performance of a company's core operations without tax expenses and capital structure costs distorting the profit figures. EBIT is calculated by the following formula:
EBIT = Net income + Interest expense + Tax expense
Since net income includes the deductions of interest expense and tax expense, they need to be added back into net income to calculate EBIT.
Operating income is a company's profit after subtracting operating expenses and the costs of running the business from total revenue. Operating income shows how much profit a company generates from its operations alone without interest or tax expenses. Operating income is calculated as gross income minus operating expenses. Operating expenses include selling, general and administrative expense (SG&A), depreciation, and amortization, and other operating expenses.
Operating income excludes taxes and interest expenses, which is why it's often referred to as EBIT. However, there are times when operating income can differ from EBIT.
Comparing EBIT and Operating Income
Below is a portion of the income statement for Macy's Inc. (M) as of May 5, 2018.
- Operating income was $238 million, highlighted in blue.
- Net income was $131 million, highlighted in green.
- Interest expense was $71 million while tax expense was $52 million, highlighted in red.
- EBIT was $254 million for the period or $131 million (net income) + $52 million (taxes) + $71 million (interest).
We can see in the above example that operating income of $238 million was different from EBIT of $254 million for the quarter. The reason for the difference is that operating income does not include non-operating income, non-operating expenses, or other income, but those numbers are included in net income. The difference in the two numbers highlights the importance of not assuming that operating income will always equal EBIT.
In the case of Macy's, we can see there was a benefit plan credit of $11 million and interest income of $5 million totaling $16 million and gives us the difference between operating income and EBIT calculations.
EBIT and operating income are both important metrics in analyzing the financial performance of a company. Our example shows the importance of using multiple metrics in analyzing the profitability of a company. For example, a company may have interest income as a key driver of revenue such as credit financing whereby EBIT would capture the interest income while operating income would not.
For more of analyzing profits, please read "How Are Gross Profit and EBITDA Different?"