What Is EBIT Used For (Why Is It Important?)

What Is EBIT Used For (Why Is It Important?)

By Russell Bowyer

EBIT is used to measure a business’s operational profits, or trading profits, so it excludes interest earned and interest costs, associated with the capital workings of a business.

EBIT is used to measure a business’s operational profits, or trading profits, and is calculated by adding-back interest paid and deducting interest income from profit before tax. These numbers can be found on the face of a profit and loss, which is included in a business’s financial statements.

Capital workings of a business include amounts borrowed and amounts sitting on deposit, together with their respective interest charged on the borrowings, and the interest received on the money held on deposit.

EBIT also excludes taxes charged on those trading profits, as taxes are not a trading expense.

EBIT is used to strip-back the profits to those generated from actual operations, which includes sales, cost of sales, and operating expenses or overheads.

Why is EBIT important to use?

The reason why this is important, is if you are interested in buying the business, by stripping out non-trading income and costs, you get a better idea of the true trading profitability of the business.

If the business has loans, it’s likely these will be repaid on completion or close of the business sale, which means the interest charged to the profit and loss no longer applies.

Also, if the business has cash in excess of operational requirements, which is over and above working capital needs, this cash is likely to be paid to the seller.

It’s likely this cash will be repaid before completing the sale, as a pre-sale dividend, or better still, to be paid as part of the sale proceeds, to save the seller tax on the transaction.

Which means, that as this excess cash, which is likely to be held on deposit earning interest, will no longer be present post-sale, the interest income generated from this excess cash on deposit, needs to be excluded from profits too.

EBIT can be used to value small businesses

EBIT can be used for business valuation purposes, and is a better profit metric to use for a business valuation, instead of EBITDA, because if EBITDA is used, the business will be over valued.

However, having said that if you use EBIT to value a business, there are still other adjustments to make to these profits before they can be used to value a small business.

If you have any questions on this topic about EBIT, or on any other aspect about a business or the process involved in buying a business, please drop a comment below.

And always remember that no question is a stupid question, if you don’t know it, you don’t know it, and by having the answer to a question you have, might be all it takes to move to the very next step in your journey to buy a business.