In summary, to calculate EBIT, we need to subtract the costs of goods sold and operating expenses from sales revenue.
To determine EBIT (operating profit), we firstly need to understand the format of the income statement.
Income Statement Format
Sales revenue
LESS: Cost of goods sold
= Gross profit
LESS: Operating expenses
= EBIT (earnings before interest and tax/operating profit)
LESS: Interest
= Net profit before tax
LESS: Taxes
= Net profit after tax
LESS: Preferred stock dividends
= Earnings available for common stockholders
Therefore, to determine EBIT, all we need to do is to subtract the cost of goods sold and operating expenses from sales revenue.
Other uses for EBIT
1 – Calculate the Operating Profit Margin Ratio = Operating profit (EBIT) / Sales The operating profit margin measures how much of each sales dollar remains after all costs except for interest, tax and preferred dividends are deducted. In other words it measures how efficient the business manages its operations or how efficiently the firm manages its income statement (keeping a healthy balance between sales and costs).
2 – Calculate the Times Interest Earned Ratio = EBIT/Interest
The times interest earned ratio (Interest Coverage Ratio) measures the ability of the enterprise to meet its financial obligations (interest payments on debt that come due).
