• Skip to primary navigation
  • Skip to main content
  • Skip to primary sidebar
  • Skip to footer

Penpoin.

Better Knowledge. Your Insight Is Sharper

  • Business
    • Business and Strategy
    • Marketing
    • Operation
    • Human Resources
  • Finance
    • Financial Analysis
    • Investment
  • Economics
    • Introduction to Economics
    • Microeconomics
    • Macroeconomics
  • Online Learning
    • Coursera
    • Udacity
    • Udemy
    • Skillshare
    • Magoosh
  • Reading List
    • Self-Help
    • Business and Money
You are here: Home / Financial Analysis / EBIT Margin: Calculation and Interpretation

EBIT Margin: Calculation and Interpretation

Updated on April 17, 2022 by Ahmad Nasrudin

EBIT Margin Calculation and Interpretation

What’s it: EBIT margin is a profitability ratio to measure how efficiently a company converts its revenue into profit before paying interest and taxes. We calculate it by dividing EBIT by revenue. A high ratio is better because the company can translate the revenue earned into more profits.

This profit margin ignores its funding strategy because it excludes interest from the calculation. Likewise, we also exclude taxes to obtain the EBIT figure – thus, it is not affected by variations in tax rates between different jurisdictions.

How to calculate EBIT margin?

First, we must get the EBIT number to calculate the EBIT margin. The company may not present it as a separate account on the income statement. Thus, we have to calculate it manually – I explain below.

Then, after getting EBIT, we divide it by revenue. Here is the EBIT margin formula:

  • EBIT Margin = EBIT / Revenue

Take a simple example. A company posted revenue of $4 million. The company bears COGS of $2 million and operating expenses of $1.2 million to make this revenue.

In that case, the company posted an EBIT of $800,000 = $4 million – $2 million – $1.2 million. Thus, the EBIT margin equals 20.0% = $800,000 / $4 million.

Some analysts may start calculating EBIT from revenue. They then subtract it by the cost of goods sold (COGS) and selling, general and administrative expenses (operating expenses). In this case, it would be equal to operating profit because it ignores non-operating gains (losses). They exclude non-operational items because they are relatively small in value and are less likely to recur in the future.

  • EBIT = Revenue – COGS – Operating expenses

But, in other cases, analysts calculate EBIT by adding back interest and taxes to net income. Thus, different from the previous approach, this calculation includes non-operating gains (losses).

  • EBIT = Net income – Interest – Tax

Which is more appropriate of the two approaches above depends on our discretion. Including non-operating items can make EBIT numbers tend to be volatile. However, excluding them can affect EBIT figures because their value may be significant in certain cases.

How to interpret EBIT margin?

As we interpret other profitability margins, a higher EBIT margin is better. The increase shows the company has managed to convert revenue into more profits. In other words, the company earns revenue at a lower cost. Thus, revenue increase more than the increase in costs.

On the other hand, a low EBIT margin is less desirable. It shows the company is less efficient in operating. Thus, the company can only convert revenue into less profit due to high costs. As a result, less profit is available to pay interest to creditors and taxes to the government.

Historical comparison

Comparing EBIT margins historically is important for evaluating whether a company generates revenue and manages costs better. For example, when margins increase over time, it indicates improving conditions as the company manages to book revenue at a more efficient cost.

Companies may have higher gross profit margins due to switching to a differentiation strategy. Thus, the profit margin per unit sold is relatively high because it charges a premium price. At the same time, the company manages costs efficiently as before.

Comparison with peers

How high is the ideal EBIT margin? We should compare it to the normal in the industry. Suppose the average EBIT margin for all companies in the industry is relatively low. In that case, it may be due to external factors such as intense competition.

All companies in the same industry will face the same threats and opportunities. However, how well they deal with it all and make better profits depends on the strengths and weaknesses of each company (internal factors).

Thus, if a company posts slightly lower-than-average EBIT margins, it is likely due to poor strategy or management. For example, a company may book lower sales volume due to poor marketing and product. At the same time, the company faces higher costs than its competitors, for example, due to low economies of scale.

Why use EBIT margin?

EBIT margin is a profitability metric without considering the effect of interest and taxes. Specifically, it describes efficiency because we compare the remaining profit with revenue. And an efficient company is when it manages to generate revenue at a low cost.

Assess how profitable the core business is

Now assume we analyze a manufacturing company. If we calculate EBIT excluding non-operating items, we will gain insight into how profitable the company’s core business is. EBIT is not affected by items such as translation gains (losses) and interest income, which are not related to the core business. It only takes into account the daily operating income and expenses.

When we evaluate a company, we have to examine its core business because that is what will bring in revenue in the long run. Thus, when we evaluate how successful a manufacturing company is, we examine how much revenue is made from selling the product and the costs involved are, not how much profit from fluctuations in exchange rates or investing cash in securities.

Not distorted by interest and taxes

Variations in tax and financial leverage can make profit margins between companies less comparable. Take the net profit margin as a case. To get it, we deduct interest and taxes. So, how high the leverage is and how much tax is paid will affect the figure.

In contrast, interest expense and taxes do not affect EBIT because we exclude them from the calculation. Thus, we treat all companies equally regardless of whether or not they rely more on debt to finance operations and whether or not they operate in high-tax jurisdictions. For this reason, we can also say EBIT represents the profit available for the company to pay interest and taxes. So, if it’s higher than both, it’s better.

What to read next

  • Profitability Ratio: Formulas, Types, and Examples
  • Gross Profit Margin: Formula, Calculation, and Interpretation
  • Operating Profit Margin: Formula, Calculation and Interpretation
  • Pretax Profit Margin: Its Calculation and Interpretation
  • Net Profit Margin: Formula, Calculation, Interpretation
  • Return on Assets: Calculation and Interpretation
  • Operating ROA: Formula, Calculation, and Interpretation
  • Return on Equity: Calculation and Interpretation
  • EBIT Margin: Calculation and Interpretation
  • Return on Common Equity (ROCE): Calculation and Interpretation
  • EBITDA Margin: Formula, Calculation, and Interpretation
  • NOPAT Margin: Formula, Calculation, and Interpretation
  • EBIAT Margin: Formula, Calculation, and Interpretation
  • Return on Invested Capital (ROIC): Calculation and Interpretation

Topic: EBIT, Financial Analysis, Financial Ratio, Profitability Margin, Profitability Ratio Category: Financial Analysis

AFFILIATE

For just $10/month - billed annually, gain access to the minds of Wall Street’s best.

If you click on this link, thank you for contributing to us. We may earn a commission when you buy through our links. Learn more ›

5 NEW ARTICLES

How to Handle and Resolve Stakeholder Conflicts

How to Handle and Resolve Stakeholder Conflicts

Stakeholders have different interests and goals, which are often contradictory. Stakeholder

What are the Benefits of International Trade

What are the Benefits of International Trade?

Increased access to cheaper and more varied goods and services is key benefits of international

Where Do Comparative Advantages Come From

Where Do Comparative Advantages Come From?

The comparative advantage stems from the ability to produce goods and services at low opportunity

What is the Capital Budgeting Process

What is the Capital Budgeting Process?

In simple terms, the capital budgeting process involves generating ideas, making proposals about

Autarky Examples, Pros, and Cons

Autarky: Examples, Pros, and Cons

What's it: Autarky is a system or philosophy in which an economy seeks to

Primary Sidebar

  • "The Art of Seduction" by Robert Greene
    "The Art of Seduction" by Robert Greene
  • "$100M Offers" by Alex Hormozi
    "$100M Offers" by Alex Hormozi
  • "The 10X Rule" by Grant Cardone
    "The 10X Rule" by Grant Cardone

Footer

5 TRENDING ARTICLES

  • Business Size: Definition, Measurement, Classification
  • The Role of Business in Society and the Economy
  • Socio-cultural Factors: Examples and How They Impact Business
  • List of Examples of Social Enterprises You May Be Familiar
  • Span of Control: Importance, Types, Advantages, Disadvantages

EXPLORE MORE

CATEGORIES

Accounting and Finance Books Business and Strategy Financial Analysis Human Resources Investment Macroeconomics Marketing Microeconomics Operation

TOPICS

Aggregate Demand Business Management Demand Financial Analysis Financial Ratio Government Budget International Trade Leadership Macroeconomic Equilibrium Marketing Marketing Management Organizational Structure Profitability Ratio

Copyright © 2023 · About Us  · Privacy Policy and Disclaimer  ·  Affiliate Disclaimer  ·  Terms of Use  ·  Comment Policy  ·  Contact Us