Operating profit and earnings before interest and taxes are similar measures of business profitability -- so much so that the two terms are often used interchangeably. Nevertheless, operating profit and EBIT are different concepts. One distinction is that they are calculated in different ways. Another is that operating profit is an entry on a firm's income statement. Generally accepted accounting principles do not allow EBIT on income statements.
Operating profit is the money a business earns from its normal day-to-day business operations before allowing for interest, income taxes and certain other amounts. On an income statement, operating profit is calculated starting with a company's revenues. Expenses then are subtracted, including:
- Cost of goods sold
- Labor costs
- Overhead and administrative costs
A number of items are not included in this figure. Instead, they are dealt with later on the income statement. Interest paid and income taxes are excluded, as are interest income and investment earnings. Non-recurring expenses such as the cost of legal judgments and accounting adjustments are not factored into operating profit.
The EBIT Metric
Earnings before interest and taxes, like operating profit, measures the profitability of a business before taking interest expenses and income taxes into account. However, EBIT is calculated using information from an existing income statement and adding the interest and taxes to net earnings. This method produces a figure that approximates operating profit. The two may not be identical, because the EBIT calculation doesn't allow for non-recurring income and expenses, or income from sources other than a firm's ongoing operations.
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Significance of Operating Profit and EBIT
Operating profit and EBIT are useful measures to evaluate not only a company's profitability but also management performance and the efficiency of its operational activities.. A higher percentage of profit is a positive indicator. Typical percentages of operating profit or EBIT vary from industry to industry. For instance, the percentage for a retailer is likely to be smaller than for a firm engaged in capital-intensive manufacturing. EBIT or operating profit are most effective when used to compare businesses within the same industry.