3.2.1. EBIT and Friends
Recall from Chapter 1 that EBIT stands for earnings before interest and taxes. EBIT and operating income are sometimes treated as if they are interchangeable, including on some exam questions. But be careful—this is only correct if there isn’t any non-operating income. But if there is non-operating income, such as interest income, that also counts toward EBIT. (EBIT does not include interest expense, hence the name.)
To derive a company’s EBIT, start with its income statement. If the income statement reports operating income (not all do), add non-operating income to get EBIT. If operating income is not shown on the income statement, then take net income and add back in interest expense and taxes. This gives you EBIT, because net income already includes both operating and non-operating income.
EBIT = operating income + non-operating income
or
EBIT = net income + interest expense + taxes
Remember: Before treating EBIT and operating income interchangeably, double-check whether there is any non-operating income. If there is none, then EBIT equals operating income.
EBIT is the basis for several other commonly used metrics. Earnings before interest, taxes, depreciation, and amortization (EBITDA) (pronounced ee’-bit-da) is frequently used as a measure of a company’s operating profitability and as a proxy for operating cash flow. EBITDA is not a perfect metric; it is easier to manipulate than cash flow, for one thing, and it can exaggerate a