Difference Between EBIT and PBIT

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between EBIT and PBIT Difference Between EBIT and PBIT

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Introduction

Earnings before interest and tax and profit before interest and tax are considered synonymous terms by foundation-level students and amateur investors. However, there are some differences between the two terms that need to be recognized in order to understand the scope of each term in its totality. These differences are best known to regular investors, auditors, accountants and even students pursuing their higher education in the field of commerce. Earnings before interest and tax represent the earnings of a firm before deducting interest and tax. Profit before interest and tax represents the profitability of a firm before deducing interest and tax. This article attempts to demonstrate the critical differences between earnings before interest and tax and profit before interest and tax to reach a clear understanding of the two terms. It also attempts to explain the concept of earnings before interest and tax in detail and its calculation and gives the format for the calculation of profit before interest and tax.

Earnings Before Interest and Tax vs Profit Before Interest and Tax

The critical difference between earnings before interest and tax and profit before interest and tax is that the former represents the earnings of a firm before deducting interest and tax, while the latter represents the profitability of a firm (revenue-operating cost=profit) before deducing interest and tax. Earnings before interest and tax are calculated by adding operating and non-operating income and subtracting operating expenses from it earned by a firm. Profit before interest and tax is calculated by subtracting the operating costs of a firm from the revenue earned by it. Earnings before interest and tax are used to measure the profitability of the firm, while profit before interest and tax are used to measure the profit and the operating income of firms. Earnings before interest and tax are used by investors to ascertain the operating efficiency of the firm, while profit before interest and tax are used by investors to identify the enterprises that have the least amount of amortization and depreciation activities. Earnings before interest and tax can be a slightly misleading indicator as the interests on the firm’s existing debts may be quite significant. On the other hand, profit before interest and tax serves as a better indicator of the profitability and efficiency of an enterprise. Thus, although both EBIT concepts are used to measure the profitability of an enterprise, the more suitable indicator of profitable investment is PBIT.

Difference Between Earnings Before Interest and Tax and Profit Before Interest and Tax in Tabular Form

Table: Earnings Before Interest and Tax vs Profit Before Interest and Tax
Parameters of Comparison
EBIT
PBIT
Full form
EBIT is the short form for the concept of earnings before interest and tax.
PBIT is the short form profit before interest and tax.
Definition
Earnings before interest and tax represent the earnings of a firm before deducting interest and tax.
Profit before interest and tax represents the profitability of a firm (revenue-operating cost=profit) before deducing interest and tax.
Calculation
EBIT= Net income + Interest +Tax
PBIT=Revenue from operations + other income - operating expenses
What do they measure?
Earnings before interest and tax are used to measure the profitability of the firm.
Profit before interest and tax are used to measure the profit and the operating income of firms.
Usage by investors
Earnings before interest and tax are used by investors to ascertain the operating efficiency of the firm.
Profit before interest and tax is used by investors to identify the enterprises that have the least amount of depreciation and amortization activities.
Suitable indicator
Earnings before interest and tax are not the best indicator of a profitable investment.
Between Earnings before interest and tax and profit before interest and tax, the latter is the more suitable indicator of a profitable investment.

What are Earnings Before Interest and Tax?

Earnings before interest and tax measure a firm's net income before interest and tax expenses. The larger a company's EBIT value, the more profitable the company is likely to be. It is calculated by subtracting expenses, usually the cost of goods sold, as well as selling and administrative expenses, from revenues. It measures the profit a company generates from its operations, making it synonymous with operating profit. By ignoring taxes and interest expenses, it focuses only on an enterprise's ability to generate revenue from operations. It ignores variables such as the tax burden and capital structure. It is extremely useful because it helps to identify a company's ability to generate enough earnings to be profitable, pay down debt, and ongoing fund operations.

What are Earnings before interest and tax mainly used for?

Earnings before interest and tax are used to evaluate a company's earning potential while serving as a crucial consideration in changing the capital structure of the business. It is also used by investors to identify the most profitable companies in terms of operating efficiency. It is not highly recommended to rely only on earnings before interest and tax for profitability appraisal, as even significantly leveraged companies can be a poor investment once their debt is considered. Sole reliance on earnings before interest and tax can also conceal a company’s taxation issues, and in such cases, a seemingly promising investment might turn out to be the opposite.

Calculation of Earnings before interest and tax

Earnings before interest and tax may be calculated as

  1. EBIT=Total Revenue earned - operating costs
  2. EBIT = Net Income + Interest + Taxes

Analyse the debt of a company with its earnings before interest and tax

Earnings before interest and tax are helpful in analysing the profile of companies that are involved in capital-intensive industries, meaning that the corporations have a significant amount of fixed assets on their balance sheets. Fixed assets are physical property, plants, and equipment. They are usually financed by raising debt. For example, companies operating in the oil and gas industry are capital-intensive. This is because they have to finance their oil rigs and drilling equipment. Due to this reason, capital-intensive industries have high-interest expenses since they have a large amount of debt showcased on their balance sheet. Companies in capital-intensive industries might have more debt when compared to one another. Thus the companies would have more interest expenses when compared to each other. It helps investors to analyse companies' operating performance and earnings potential while stripping out debt and the resulting interest expense.

Limitations of using Earnings before interest and tax

  1. Depreciation is included in the calculation of EBIT and may lead to varying results while comparing the profile of companies engaged in different industries. If an investor is comparing a company that owns a large number of fixed assets to a company that owns a smaller amount of fixed assets, the depreciation expense will have a negative effect on the company with the greater amount of fixed assets since the expense reduces net income or profit.
  2. Companies running on a large amount of debt are more likely to have a high amount of interest-related expenses. EBIT excludes the interest expense and therefore inflates a company's potential to earn, especially if the company is running on a substantial amount of debt. Not including debt in the analysis may cause problems if the corporation increases its debt due to a lack of cash flow or even poor sales performance. In a rising rate environment, interest expenses will rise for companies that have a greater amount of debt on their balance sheet. This must be considered when analysing the financials of a company.
  3. Calculating EBIT can be quite challenging, especially for investors who are unfamiliar with it. Anyone struggling with determining the value of EBIT may want to consider reaching out to one of the best online accounting firms.

What is Profit Before Interest and Tax?

Format for calculating profit before interest and tax:

PARTICULARS

I revenue from operations                                                                                              

II Other income

III Total Revenue

IV Expenses

Cost of materials consumed

Purchase of stock in trade

Changes in inventories of finished goods

Work in progress and stock in trade

Employee benefit expenses

Finance costs

Depreciation and amortization expenses

Other expenses

Total expenses

V Profit before interest and tax (III-IV)

AMOUNT (IN RUPEES)

Revenue from operations means the revenue earned by a company from its operating activities.

II Other income means income earned by a company from its non-operating activities.

III Total revenue is the sum of revenue from operations and other income.

IV Expenses

  1. The cost of materials consumed means the cost of raw materials and other materials used in the manufacturing of goods.
  2. Purchase of stock in trade refers to the goods purchased for reselling.
  3. Changes in inventories of finished goods, work in progress, and stock in trade means the difference between opening stock and closing stock of final/finished goods, work in progress, and stock in trade.
  4. Employee benefit expenses mean payments made to and for the benefit of employees.
  5. Finance costs mean costs incurred by the company on borrowings and expenses incurred for borrowings.
  6. Depreciation and amortization expenses are the gradual fall in the value of tangible and intangible assets.
  7. Other expenses are the expenses that are not covered under the six heads specified above. They may be shown as direct and indirect expenses.

How is profit before interest and tax useful?

Profit before interest and tax is typically a critical performance indicator on the income statement/statement of profit and loss. These are generally focused on gross profit, operating profit, and net profit. However, like interest, the isolation of a company's tax payments can be an interesting and important metric for cost efficiency management. It also determines the amount of interest and tax a company will pay. Any credits would be taken from the tax obligation rather than deducted from it. Further, excluding the interest and tax provides managers and stakeholders with another measure for which to analyze margins. A PBIT margin will be higher than the net income margin because tax is not included. The difference in PBIT margin vs net margin will depend on the amount of interest and taxes paid. Between Earnings before interest and tax and profit before interest and tax, the latter is the more suitable indicator of a profitable investment.

Main Differences Between Earnings Before Interest and Tax and Profit Before Interest and Tax In Points

  1. The acronym for Earnings before interest and tax is EBIT. The acronym for profit before interest and tax is PBIT.
  2. Earnings before interest and tax represent the earnings of a firm prior to deduction of interest and tax, whereas profit before interest and tax represents the profitability of the enterprise (and not its earnings) prior to deduction of interest and tax.
  3. The calculation for EBIT is: Net income + Interest +Tax. The calculation for PBIT is: revenue from operations + other income - operating expenses.
  4. Earnings before interest and tax are primarily used to measure the profitability of the enterprise, while profit before interest and tax is used to measure the profit as well as the operating income of the enterprise.
  5. Investors typically use EBIT to ascertain the operating efficiency of the firm. In contrast, PBIT is used by investors only to identify the firm that has the least amount of amortization and depreciation expenses.
  6. Between EBIT AND PBIT, the latter is the more suitable indicator of a profitable investment as it considers depreciation and amortization expenses incurred by the firm.

Conclusion

Two terms commonly used in accounting and auditing are Earnings before interest and tax (commonly referred to as EBIT) and Profit before interest and tax (commonly referred to as PBIT). Both the terms are often used to convey the same meaning, while they are in stark contrast to each other. Earnings before interest and tax and profit before interest and tax are both used to examine the profitability of a firm. Earnings before interest and tax represent the earnings of a firm before deducting interest and tax, while the profit before interest and tax represents the profitability of a firm (revenue-operating cost=profit) before deducting interest and tax. This article has effectively explained the differences between earnings before interest and tax and profit before interest and tax to reach a clear understanding of the two terms. It has explained the concept of earnings before interest and tax in detail, covering usage, limitations, relationship with debt and its calculation. It had also given the format for the calculation of profit before interest and tax and explains the various items considered while calculating profit before interest and tax usefulness.


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"Difference Between EBIT and PBIT." Diffzy.com, 2022. Sun. 25 Sep. 2022. <https://www.diffzy.com/article/difference-between-ebit-and-pbit-716>.



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