EBIT

What is EBIT?

EBIT is a company's result before interest and taxes on profit but after depreciation and amortisation. The abbreviation stands for Earnings before Interest and Taxes (German: Ergebnis vor Zinsen und Steuern); in common usage it is often called the operating result. Taxes on profit are, for a GmbH (German limited liability company), corporation tax and trade tax. Unlike with EBITDA, depreciation and amortisation have already been deducted. They spread the acquisition costs of machinery, buildings, software and acquired rights as an expense over the years of their use and thus reflect their consumption of value.

A craft business with its own van makes the difference tangible: the annual loss of value of the van is part of the costs of the business. The loan interest is not, because it depends only on whether the van was bought for cash or on credit.

EBIT is not defined by law. The key figure appears in the financial statement analysis of banks, in valuation reports, in purchase price negotiations and in loan agreements. Because it does not depend on whether a company is financed with equity or debt, it is suitable for comparing companies with different capital structures, that is, different levels of debt.

Calculating EBIT: derivation from the income statement

From an income statement under the nature of expense method (Section 275(2) of the German Commercial Code (HGB)), EBIT can be determined in two ways. Forwards, it comprises items no. 1 to 8, that is, revenue and other operating income less cost of materials, personnel and other operating expenses and depreciation and amortisation. Other taxes (no. 16), such as property tax, must also be deducted. Backwards, net income for the year is increased by taxes on income and earnings (no. 14), and the financial result (nos. 9 to 13) is stripped out. A negative financial result is added back, a positive one deducted. Both routes lead to the same value.

Formula: EBIT = net income for the year + income taxes - financial result = EBITDA - depreciation and amortisation

Under the cost of sales method (Section 275(3) HGB), depreciation and amortisation are already included in cost of production, selling and administrative expenses. EBIT results there directly from gross profit less selling and general administrative expenses, plus other operating income and less other operating expenses. Other taxes are widely treated as operating expense under both methods and reduce EBIT. The same treatment applies to EBITDA and adjusted EBITDA, so that all three figures rest on a uniform delineation.

Financial result: income from participations, interest and unwinding of discount

The financial result comprises the income and expenses from investments of funds, participations and loans. Under the widespread definition, it remains entirely outside EBIT. This includes income from participations, from securities and from long-term loans granted (loans of financial fixed assets) as well as other interest and similar income. On the expense side, write-downs of financial assets and of securities held as current assets as well as interest and similar expenses belong to it. Behind this lies the logic of business valuation. What is missing from EBIT is captured elsewhere. Interest income arises from liquid funds, and these are netted in net debt (financial debt less liquid funds). Participations are valued as separate assets.

Deviations are possible but must be expressly agreed. If a participation is part of the operating business, for example a joint sales company with a partner, a definition may include its income in EBIT. The participation must then not be counted a second time in the bridge to equity value, the calculation from enterprise value to the value of the shares.

A peculiarity of the HGB concerns long-term provisions. Expenses from their unwinding of discount, above all for pension provisions, must be shown in interest expense under Section 277(5) HGB. They therefore do not reduce EBIT. The provision itself is regularly deducted from the enterprise value in determining the purchase price as a debt-like item, that is, treated like financial debt although it is not a loan.

EBIT and operating result in cost accounting

EBIT is often equated with the operating result (Betriebsergebnis), which is true only to a limited extent. Cost and performance accounting is the internal calculation with which a company calculates prices and manages divisions. Its operating result sets operating output against costs and works with imputed figures. These include depreciation on replacement values instead of acquisition costs, imputed interest on the capital required for operations and, for partnerships, often an imputed entrepreneur's salary. Non-operating, out-of-period and extraordinary items are separated out as the neutral result.

EBIT, by contrast, is based on the valuation amounts of the annual financial statements, also contains out-of-period operating items and knows no imputed interest. The operating result of a business management evaluation (betriebswirtschaftliche Auswertung, BWA) lies, depending on the allocation of accounts, close to EBIT but partly delineates neutral items differently. For comparisons, it must therefore be stated which figure is meant.

EBIT in valuation and financing

EBIT margin

The EBIT margin shows how much of revenue is left after all operating expenses including depreciation and amortisation. It is one of the common forms of return on sales.

Formula: EBIT margin = EBIT / revenue × 100%

EV/EBIT multiple

Multiples convert a result into a value. For capital-intensive companies, for example in manufacturing, logistics or the operation of their own data centres, the ratio of enterprise value to EBIT is more meaningful than the EBITDA multiple. Depreciation and amortisation there roughly stand for the ongoing reinvestment requirement that an EBITDA multiple hides. The precondition is that they reflect the actual consumption of value and are not distorted by special write-offs or the amortisation of acquired goodwill.

Interest coverage ratio

The interest coverage ratio sets a result before interest in relation to interest expense and shows how many times the operating result covers the interest burden. In loan agreements it is usually agreed on the basis of EBITDA. In credit analysis it is also calculated with EBIT, which takes the consumption of value of fixed assets into account and is therefore stricter. It must be distinguished from the tax interest barrier (Zinsschranke), which limits the tax deduction of high interest expenses. For it, under Section 4h of the German Income Tax Act (EStG), for corporations in conjunction with Section 8a of the German Corporation Tax Act (KStG), what counts is not EBIT but a tax-determined EBITDA.

Worked example: EBIT, EBIT margin and EV/EBIT compared

Two companies report the same EBITDA of EUR 3.0 million and are each offered at an enterprise value of EUR 24.0 million. Company A develops and sells software. Company B is a contract manufacturer with its own machinery and holds a minority participation in a supplier.

• Company A: revenue EUR 15.0 million, depreciation and amortisation EUR 0.3 million, EBIT 3.0 minus 0.3 = EUR 2.7 million, EBIT margin 2.7 / 15.0 = 18%
• Company B: revenue EUR 30.0 million, depreciation and amortisation EUR 1.5 million, EBIT 3.0 minus 1.5 = EUR 1.5 million, EBIT margin 1.5 / 30.0 = 5%
• EV/EBITDA for both: 24.0 / 3.0 = 8.0
• EV/EBIT: A 24.0 / 2.7 = about 8.9; B 24.0 / 1.5 = 16.0
• Interest coverage on an EBIT basis with interest expense of EUR 0.1 million (A) and EUR 0.5 million (B): A 2.7 / 0.1 = 27; B 1.5 / 0.5 = 3
• Profit before tax of B with income from participations of EUR 0.2 million: 1.5 plus 0.2 minus 0.5 = EUR 1.2 million; B's EBIT remains at EUR 1.5 million

On the basis of EBITDA, both offers appear equally expensive. If depreciation and amortisation correspond to the ongoing reinvestment requirement, EBIT shows that at B half of EBITDA is needed to maintain the machinery. A buyer who pays the same price for B pays almost twice as much per euro of EBIT as for A. The low interest coverage at the same time limits the scope for debt financing of the purchase price.

Distinctions: EBIT, EBITDA, EBITA, EBT, NOPAT and operating result

• EBITDA: the result additionally before depreciation and amortisation. It is independent of depreciation methods and investment cycles but hides the consumption of value of fixed assets.
• EBITA: EBIT before amortisation of intangible assets, usually only of goodwill and other intangible assets acquired in acquisitions. It shows earning power after acquisitions without their amortisation.
• EBT: the result before income taxes (Earnings before Taxes), that is, EBIT plus a positive or minus a negative financial result. It depends on the financing structure and is therefore less suitable for comparing companies with different levels of debt.
• Operating result: in cost accounting a figure with imputed costs and without neutral items; in general usage often a synonym for EBIT.
• NOPAT: EBIT less the taxes that would arise on it without deduction of interest (Net Operating Profit after Taxes); starting point of the free cash flow planning in the DCF valuation.

Common mistakes

• Income from participations unchecked in EBIT. If it is included and the participation is also valued as an asset, the same value counts twice.
• Cost accounting and annual financial statements mixed. An operating result after imputed interest is not comparable with an EBIT from the annual financial statements.
• Goodwill amortisation not shown separately. After an acquisition, the scheduled amortisation of acquired goodwill reduces EBIT under the HGB. This is the part of the purchase price that exceeds the recognised assets of the company bought. For assessing operating earning power, it is often shown separately.
• EBITDA multiples with high fixed assets. They conceal differences in reinvestment requirements that only become visible in EBIT.
• One-off income overlooked. Book gains from sales of assets or the release of provisions are in other operating income and raise EBIT without being recurring.

Frequently asked questions

How is EBIT calculated?

Most simply from net income for the year: income taxes and interest expense are added, interest income is deducted. With net income of EUR 500,000, income taxes of EUR 230,000, interest expense of EUR 120,000 and interest income of EUR 10,000, EBIT is EUR 840,000. The calculation EBITDA minus depreciation and amortisation leads to the same value.

What is the difference between EBIT and EBITDA?

Depreciation and amortisation: EBIT is EBITDA after depreciation and amortisation. It is preferable where depreciation and amortisation are a material and recurring expense. For companies with high fixed assets, EBIT reflects sustainable earning power better; for software companies with low investment, the two figures differ little.

What is a good EBIT margin?

There is no universal threshold, because the margin depends on business model and capital intensity. In the worked example, the software provider achieves 18% and the contract manufacturer 5%, although both report the same EBITDA. What is meaningful is the comparison with similar companies and the development over several years. A margin that rises with revenue indicates economies of scale.

Is EBIT the same as operating result?

In general usage usually yes. Neither term is defined in the HGB. As soon as a figure has contractual effect, the exact definition must be fixed. This applies, for example, to a loan agreement or an earn-out clause under which part of the purchase price depends on future results.

Does interest income on bank balances belong in EBIT?

Under the widespread definition, no. In valuation, liquid funds are netted with financial liabilities, so their income belongs in the financial result.

How is a company with negative EBIT valued?

Not through an EBIT multiple, because a negative ratio carries no meaning. The valuation then rests on revenue multiples, on comparable transactions or on a DCF valuation, which discounts the planned future cash surpluses to today.

The Roemer Capital view

In company sales and succession solutions with significant fixed assets, Roemer Capital places EBIT on an equal footing with EBITDA. Buyers calculate out the reinvestment requirement anyway. Anyone who shows it openly in their own presentation and backs it with an investment plan controls the discussion of the figures.

In preparation, Roemer Capital reviews every item between EBIT and net income for the year and assigns participations, pension provisions and shareholder loans to the bridge to the purchase price. Tax questions such as the interest barrier are clarified by the client's tax adviser; Roemer Capital prepares the figures for this.