EBIT: what it means, the formula, and a worked example from a small business

Short answer: EBIT means earnings before interest and tax. It is the profit a business makes before it pays interest on its loans and before income tax or company tax. There are two ways to get it, and they give the same answer:

• From the top: EBIT = sales − cost of sales − operating expenses (with loan interest left out) + other income
• From the bottom: EBIT = net profit after tax + tax + interest paid

Because it ignores how the business is funded and what it pays in tax, EBIT lets you compare years (or businesses) with different loans. Lenders use it for interest cover (EBIT ÷ interest), and EBIT margin is EBIT ÷ sales × 100. For most small businesses EBIT is the same as operating profit; the two only differ when there is non-trading income such as interest received or a gain on selling equipment.

The EBIT formula, both ways

From the top (the Profit and Loss order)	From the bottom (working back)
Sales	Net profit after tax
− Cost of sales	+ Income tax or company tax
= Gross profit	+ Interest paid on loans, overdrafts, hire purchase and car finance
− Operating expenses, including wages, rent and depreciation, but not interest
+ Other income (interest received, gains on sale)
= EBIT	= EBIT

Some lenders and buyers also take interest received and one-off gains out, so EBIT shows only the trading result. That version is operating profit. If someone asks for your EBIT, ask which they mean, because in a year with an unusual item the two can be far apart.

What EBIT never adds back: loan repayments (the principal is not an expense, see loan repayments in Xero), owner drawings or dividends, or depreciation (that is EBITDA).

A worked example: a plumbing company in Australia

These are made-up figures for one year of a small plumbing company (a Pty Ltd) with a loan on its vans and equipment. Every amount excludes GST.

	$	% of sales
Sales	1,200,000
Cost of sales (materials, subcontractors)	540,000
Gross profit	660,000	55.0%
Wages and super	410,000
Rent, vehicles, insurance, software and other overheads	104,000
Depreciation	38,000
Operating profit	108,000	9.0%
Interest received	2,000
EBIT	110,000	9.2%
Interest on the equipment loan	(30,000)
Net profit before tax	80,000	6.7%
Company tax at 25%	(20,000)
Net profit after tax	60,000	5.0%

Working back from the bottom gives the same figure: 60,000 + 20,000 tax + 30,000 interest = $110,000. Take out the $2,000 of interest received and you are back at the $108,000 operating profit.

From the same numbers:

• EBIT margin = 110,000 ÷ 1,200,000 × 100 = 9.2%. Out of every $100 of sales, $9.20 is left to pay the lender, the tax office and the owners.
• EBITDA = 110,000 + 38,000 depreciation = $148,000 (12.3% of sales). The EBITDA calculator does this from your own Profit and Loss.
• Interest cover = EBIT ÷ interest = 110,000 ÷ 30,000 = 3.7 times. The business earns its interest bill 3.7 times over.

Interest cover: how far EBIT could fall

Interest cover is the main reason an owner gets asked for EBIT. A loan agreement may set a minimum, for example 2 or 3 times; the number, and whether the lender uses EBIT or EBITDA, is in your own loan documents.

Say this company’s loan needs interest cover of at least 2 times. EBIT can then fall to 2 × 30,000 = $60,000, which is $50,000 below today. If overheads stay the same and cost of sales moves with sales, each $1 of lost sales costs 55 cents of EBIT (the gross margin). So 50,000 ÷ 0.55 = about $91,000 less in sales, a 7.6% fall, would take cover from 3.7 to 2. A lower gross margin would get there sooner: if materials went up so the margin fell from 55% to 51%, that alone costs $48,000 of EBIT on the same sales.

Interest cover leaves out the loan principal, so it usually looks healthier than the question that matters for cash: can the business afford the full repayments? Cash flow cover and the debt service coverage ratio calculator answer that one.

EBIT vs operating profit vs EBITDA vs net profit

	Before interest?	Before tax?	Before depreciation?	Includes interest received and one-off gains?	Example above
Operating profit	Yes	Yes	No	No	$108,000
EBIT	Yes	Yes	No	Usually yes	$110,000
EBITDA	Yes	Yes	Yes	Usually yes	$148,000
Net profit before tax	No	Yes	No	Yes	$80,000
Net profit after tax	No	No	No	Yes	$60,000

Types of profit follows one company down every one of these lines, and profit before tax covers the step from EBIT to the tax bill in Australia, New Zealand and the UK.

How to get EBIT from Xero

Xero’s standard Profit and Loss (Accounting › Reports) goes Trading Income, Cost of Sales, Gross Profit, Other Income, Operating Expenses, Net Profit. There is no EBIT line. Work back from Net Profit:

1. Run the Profit and Loss for the period you need (a full year if a lender asked).
2. Find the interest expense accounts. In Xero’s default chart, loan interest is an expense account inside Operating Expenses; you may also have separate accounts for hire purchase, car finance or overdraft interest. Add them up.
3. Check whether income tax is on the report. In many small companies’ Xero files the tax expense is only posted at year end by the accountant, so during the year Xero’s Net Profit is already before tax. A sole trader’s Profit and Loss never shows income tax, because the tax is personal.
4. EBIT = Net Profit + the interest + any tax expense shown. Leave Other Income in for EBIT; take it out if you want operating profit.

For the plumbing company, Xero would show Net Profit of $80,000 (no tax posted yet) with $30,000 in the Interest Expense account, so EBIT is 80,000 + 30,000 = $110,000. How to read your Profit and Loss in Xero explains every section of that report, and the net profit calculator works down from sales to each profit line from your own figures.

Common mistakes

• Adding back loan repayments. Only the interest part is added back. The principal is not on the Profit and Loss at all.
• Adding back tax that is not there. If your accountant has not posted the tax yet, Net Profit is already before tax. Adding an estimate on top overstates EBIT.
• Forgetting interest hidden in other accounts. Bank fees are not interest, but hire purchase and car finance interest are, even when they are coded to a vehicle account.
• Treating EBIT as cash. Unpaid invoices, stock, equipment purchases, loan principal and GST or VAT all move the bank without moving EBIT. Profit in Xero but no cash in the bank explains the gap.
• Judging one year alone. A one-off gain lifts EBIT for one year only. Compare at least two years, and look at operating profit too.

Common questions

What does EBIT stand for? EBIT stands for earnings before interest and tax. It is a business’s profit before interest on loans and before income tax or company tax are taken off.

What is the formula for EBIT? EBIT equals sales minus cost of sales minus operating expenses (leaving out interest), plus any other income. Working back from the bottom line, EBIT equals net profit after tax plus tax plus interest paid. Both give the same figure.

Is EBIT the same as operating profit? For most small businesses, yes. They differ when there is non-trading income: EBIT usually includes interest received and one-off gains such as selling equipment for more than its book value, while operating profit leaves them out.

What is the difference between EBIT and EBITDA? EBITDA also adds back depreciation and amortisation. A business with a lot of vans or machinery has a much higher EBITDA than EBIT, but the equipment still wears out and has to be replaced, so EBIT is the more cautious figure.

What is a good EBIT margin? It depends heavily on the industry, so there is no single good number. Compare your EBIT margin with your own previous years, and check it is enough to cover your interest, tax, loan repayments and a fair return for the owners. A falling margin while sales grow is the warning sign to look at first.

How do I calculate interest cover from EBIT? Divide EBIT by the interest paid in the same period. A business with EBIT of 110,000 and interest of 30,000 has interest cover of 3.7 times. Your loan agreement says what minimum your lender expects and whether it uses EBIT or EBITDA.

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