Operating profit means the income that comes into a company minus the costs that went into the goods that brought that income. However, companies have more costs than just the price of their raw materials, staff and accommodation costs. EBIT reduces income by other factors, simultaneously reducing profit.
EBIT stands for “earnings before interest and tax.” This means all the profit of the company, if that company does not have any loans upon which it has to pay interest. EBIT is a good tool for investors because, although a company might not be making any profit, if its EBIT is high, then probably the company could be brought to profitability either by moving its tax domicile, or by repaying or renegotiating the company’s loans. Thus, a profitable company could be acquired cheaply because tax and interest depress the net profit figures.
Operating profit is a purer indicator of the company’s long term success than EBIT. If operating profit is low, then the company is in a market that does not give enough of a margin per item, or the company is not selling enough of the product to justify a lower price. If something in the company’s strategy is wrong, then this is laid bare by operating profit.
EBIT includes other income besides operating profit. As companies exist to make profits from their sales, then this other income can only be regarded as “exceptional items.” Exceptional items are not likely to repeat and so EBIT can be distorted and disengage from the level of operating profits. Factors that can inflate EBIT include the sale of property or an unexpected gain from currency hedging. Factors that can reduce EBIT are things like a court cost, or out of court settlement that was not covered by the company’s insurance. One-off factors should be removed from an assessment of a company’s long-term profitability.
The true value of operating profit and EBIT lies in the comparison of the two figures. Usually they should be very close. This indicates that the company has not experienced any shocks in the given year. An EBIT that is higher or lower than operating profit flags a situation that requires further investigation.
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