Company managers, employees, investors and creditors review corporate earnings each quarter. Each person looks at the earnings for different reasons. Creditors want to see that the company can repay the money it borrows. Investors want to see that the company grows in value. Employees and managers may receive bonuses based on earnings and want to determine their bonus amount. These users might wonder if earnings before interest and tax, or EBIT, include specific types of interest income or interest expense.
Interest income refers to money the company earns as a result of extending credit. For example, companies who extend credit to customers may require those customers to pay interest until the balance is paid off. This interest represents income to the company. If the company receives interest income as a result of its primary business operation, the income contributes to the regular earnings of the company and is included in EBIT. For example, the finance division of a business records interest income as regular earnings. If the company charges interest outside of its primary operation, this income is excluded from EBIT. For example, the company might charge interest to customers who pay bills late. This income falls outside of the company’s regular earnings and is excluded.
Interest expense refers to money the company pays as a result of borrowing money. Companies pay interest expense on notes payable or bonds payable, as well as convertible debt or lines of credit. In some cases, this interest may be tax deductible. The interest paid on these loans falls outside of the company’s regular expenses and is excluded from EBIT.
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EBIT provides a way for financial statement users to consider the money earned through the primary business. Managers, employees, investors and creditors want to see that the business sustains itself through its main business. Income and expenses that fall outside of the normal business reduce the user’s ability to determine if it can sustain itself. EBIT omits the interest income and expense so that it the user sees only relevant information.
EBIT appears on the company’s income statement as a separate line item. The income statement includes the revenues and expenses relevant to the business first. The company subtracts the relevant expense from the relevant revenues to calculate EBIT. Interest income and interest expense which do not contribute to the company’s primary business appear next and impact the final net income.