It’s important to be aware of the money you earn for your business. Operating profit and EBIT can help you do that. These numbers are essential to knowing your financial performance after expenses, but they aren’t the same thing.
Your operating profit and EBIT can produce different numbers. It’s crucial to know the difference because every number has a greater impact on your finances when you run a small business. Luckily, we can help.
This guide covers operating profit vs EBIT, including:
- What is operating profit?
- What is EBIT?
- What are the key differences?
What is operating profit vs EBIT?
Operating profit and EBIT refer to money you earn for your business after expenses. But they differ in which costs and profits they measure and how they measure them. Let’s define each.
Operating profit is a business’s total income minus expenses and operational costs. You subtract these expenses from your gross profit, or everything you earn from sales after the costs of making a sale.
This number shows how much money you bring in and retain for your business before taking taxes or interest costs into account. Here’s the equation to follow:
Gross profit – operating expenses = operating profit
See also: How to calculate your gross profits.
Say you earn £80,000 in gross profits for your financial year. This figure doesn’t include what you spend to make a sale, such as inventory costs.
Aside from that, say you have to pay insurance, shop rent, and marketing and business software fees. When you add that up, your operating costs were £10,000 for the year.
With these numbers, your operating profits would be:
£80,000 – £10,000 = £70,000 operating profit
The result shows what you earn for your business before paying taxes and interest towards debt.
EBIT is short for earnings before interest and taxes. Like it sounds, this term refers to a company’s income before deducting interest and tax charges.
This definition may seem like the same thing as operating profit, but the results can differ because EBIT considers net profit rather than gross profit. Since net profit doesn’t include interest and tax, you add it back in to determine EBIT.
You can calculate EBIT with this equation:
Net profit + interest + tax charges = EBIT
Let’s look at an example where EBIT and operating profit might lead to the same number. Say your company earns a net income of £50,000 after subtracting the money involved in interest and taxes.
But, you may have paid £350 in interest towards debts and £19,650 in taxes.
In this case, your EBIT would be:
£50,000 + £350 + £19,650 = £70,000 EBIT
Though this example adds up to the same amount, the numbers show different things.
Here you’d add the already determined amounts for interest and tax to show, which can show how debt affects your profit. Meanwhile, operating profit shines a light on how much it costs to run a business.
What are the key differences between operating profit and EBIT?
You might get the same number when it comes to operating profit vs EBIT. But a few key differences set them apart. Let’s go over the main things to know.
Taxes and interest
For operating profit, taxes and interest are entirely out of the equation. In other words, you haven’t subtracted them from the profits or determined their final amounts.
So, operating profit doesn’t provide insight on how much you’ll put towards these costs and how they impact your business.
On the other hand, EBIT deducts interest and taxes before adding them back. This visual is useful in comparing the effect of a company’s interest debts on their potential profits.
If you bring in a lot of revenue but put a large portion towards interest, EBIT shows what you could earn if you paid off your debts.
See also: What taxes do businesses pay?
Costs of running a business
Similarly, operating profits show what you spend on running your business. With this knowledge, you can better understand how cost-efficient your operations are.
If your operational costs are disproportionate to your profits, you may be wasting money. Noticing this allows you to clean up your operations for a more robust financial performance.
Interest income and financing
If a company has interest income or offers to finance, or take out credit on purchases, the EBIT takes this into account.
For example, say you make a big sale of £5,000 and offer a customer to pay it over 12 months with 10% annual interest. You earn £500 in interest off that sale.
EBIT lets you incorporate this interest income within your profits to see how it affects your business performance.
So, why do the minor differences matter? If a business earns income through interest, such as offering to finance for your products or services, then operating profits could vary from EBIT.
Say you earn £55,000 in gross income, with £5,000 in operational costs. Your operating income would be £50,000.
Alternatively, say you earn £38,600 from sales with £700 in interest income through financing customers. Then, your total tax charges might have been around £11,400 with £200 in interest on debts.
£38,600 + £700 interest income + £200 interest charges + £11,400 = £50,900
Use operating profit vs EBIT to assess your finances
Your operating profit and EBIT can help you determine the financial success of your business. Each can reveal the impacts of unique aspects of your finances.
Though they may feel interchangeable, calculating both lets you learn more about your performance.
As you learn about your profits, you may wonder how to improve upon them. Next, you may want to check out our article on how to make your business profitable or six proven ways to reduce business expenses.
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