The EBIT margin, also known as the operating margin or return on sales, is a measure of a company's operating profitability. EBIT stands for earnings before interest and taxes. The EBIT margin is identical to a company's profit margin except that taxes and interest are excluded from the numerator.
EBIT is a company's net income excluding interest and tax expenses. EBIT can be a useful way to evaluate companies that have different capital structures. Because of the nature of financing arrangements, companies that obtain capital through debt tend to have higher interest payments and lower taxes compared to companies that obtain capital through equity offerings. By excluding interest and taxes, investors can more easily compare the actual operating profits of the company.
To find EBIT, add tax expense and interest expense back to the company's net income. For example, if net income is $10,000 but the company listed $3,000 in taxes and $2,000 in interest expense, EBIT is $15,000.
The second part of the EBIT margin is business revenue. Revenues are the sum of all sales of products and services that the company had during the accounting period. Some businesses use net sales for the ratio instead of revenue. Net sales equal total revenue less allowance for sales returns, allowances and discounts. For example, if revenue is $50,000 and returns, allowances and discounts amount to $1,000, then net sales is $49,000.
Returns, allowances and discounts are usually a small number relative to revenue and other expenses and some companies don't even list these items. Because of this, EBIT ratios aren't significantly affected if net sales are used in lieu of revenue.
Calculating the EBIT Margin
To calculate the EBIT margin, divide EBIT by revenue. For example, if EBIT is $15,000 and revenue is $50,000, the EBIT margin would be 30 percent. A higher margin means the company gets to keep more of every dollar of revenue it makes as profit. If the EBIT margin is decreasing, it could be a sign that costs are getting out of hand or that revenues are declining.