EBIT

A profit and loss account is a waterfall. Revenue at the top, and each expense takes a cut on the way down.

EBITDA is the first stop. Take depreciation and amortisation out of it and you reach the next stop, which is EBIT.

EBIT is the profit the business earns before 2 things: the interest it owes its lenders, and the tax it owes the government. The workbook simply calls it operating profit.

It matters because of what comes next. Interest is the very next line. So EBIT is the money actually available to pay the lenders — and if it does not cover them, the company has a problem no amount of revenue growth hides.

Where it sits. Section 8.4.2 places EBIT as "the next level of profit metric in the waterfall from revenue to profits after taxes," directly below EBITDA. It is "referred to operating profit." Below EBIT come finance costs, then tax, then "Net Profit or EAT or PAT, which is the final profit available to the shareholders to be distributed as dividend or to reinvest in the business."

The workbook's own waterfall. Bharti Airtel, FY 2019, in Rs million:

One year, 2 numbers, and the gap between them is the whole point of the metric: D&A of Rs 2,13,475 million consumed 82% of EBITDA, and what survived did not cover the Rs 1,10,134 million interest bill.

What it is used for. The workbook names 3 jobs. EBIT is "a useful metric to measure the ability of the firm to meet the annual interest or financial expenses." It is a significant input for the interest coverage ratio, computed as EBIT ÷ interest expense. And it feeds free cash flow to the firm for valuation.

Two further uses appear later in chapter 8. ROCE is EBIT ÷ capital employed. And for valuation, EBIT × (1 − tax rate) = NOPAT.

The margin. Section 8.11.1 (Profitability Ratios) notes that EBIT margin is "popularly known as Operating Profit Margins."

EBIT = EBITDA − Depreciation − Amortisation

EBIT margin      = EBIT ÷ Revenue × 100
Interest coverage = EBIT ÷ Interest expense
ROCE             = EBIT ÷ Capital employed × 100
NOPAT            = EBIT × (1 − tax rate)

The workbook works this example itself, in section 8.10, to show why a number means nothing on its own. Bharti Airtel, FY 2019:

EBIT (operating profit) = Rs 47.62 billion
Revenue                 = Rs 807.8 billion
Interest expense        = over Rs 110 billion

Rs 47.62 billion "looks fairly large." Then set it against revenue:

EBIT margin = 47.62 ÷ 807.8 = 5.9%

So for every Rs 100 of service sold, less than Rs 6 survived to the operating profit line. And against interest:

Interest coverage = 47.62 ÷ 110 = 0.43 times

The workbook's conclusion is blunt: "their profit was way too inadequate to even service the interest expense."

Now compare with the prior year, where EBIT was Rs 1,10,848 million against finance costs of Rs 93,255 million — coverage of 1.19 times. Revenue barely moved. What moved was depreciation and amortisation, up from Rs 1,92,431 million to Rs 2,13,475 million, and EBITDA, down from Rs 3,03,279 million to Rs 2,61,101 million. EBIT absorbed both, and it fell 57% in a single year.

Section 8.4.2 (Key metrics from profit and loss account) defines EBIT; 8.9 uses EBIT margin; 8.11 builds the interest coverage ratio and ROCE on it; and chapter 10 uses NOPAT and free cash flow to the firm, both derived from it. Section 8.10 uses the Airtel EBIT figure as its opening illustration of why ratio analysis exists at all.

Expect a computation: given a P&L, work down from EBITDA to EBIT, or work EBIT into interest coverage. Expect a definitional question on what EBIT is struck before — interest and tax, but after depreciation and amortisation. And expect NOPAT, since EBIT × (1 − tax rate) is the one formula the workbook attaches to EBIT for valuation purposes.

• EBIT is after depreciation and amortisation; EBITDA is before. That single difference is the most examined point here, and in the Airtel year it was worth Rs 2,13,475 million.
• EBIT is before interest, so it is the right measure for testing debt service — and the wrong measure for what shareholders actually earned. PAT is the shareholders' number.
• Operating profit and EBIT are the same thing in this workbook. It says so directly, and the margin built on it is called the operating profit margin.
• NOPAT is EBIT after notional tax, not after interest. EBIT × (1 − tax rate) deliberately keeps the funding decision out of the figure.
• A large EBIT can still be a failing EBIT. The workbook's Kingfisher Airlines case in 8.6 is exactly this: EBIT much lower than interest obligations for several years, so the airline "was borrowing money to pay interest."
• Do not confuse EBIT margin with gross margin. The workbook notes Indian companies generally do not disclose direct costs separately, so gross profit often cannot be computed at all.