Earnings Before Interest and Taxes -- also affectionately known as EBIT, and also known as operating income -- tells you how much a company has earned without taking into account interest and taxes.
Earnings before interest and taxes (usually) doesn't include interest
Interest expense is money that a company pays to its lenders on a regular basis in exchange for a loan. Interest income is money a company earns on bank deposits and debt investments that it has already made.
Operating income ordinarily doesn't include interest, because interest is money a company owes (or earns) on financing. It isn't directly associated with the things a company sells, or with the day-to-day operations of a business.
For example, Cal-Maine Foods, a major egg packager and seller, finished fiscal 2015 with $356 million in cash and investments that it held in bank deposits, commercial paper, government bonds, and so forth. That year, Cal-Maine earned $1.8 million in interest on its investments. (It also got another $6.9 million in dividends.) At the same time, Cal-Maine owed $50.9 million to its lenders, which generated $2.3 million in interest expenses.
Cal-Maine's business, however, isn't to collect interest on its bank deposits -- it's raising and breeding chickens, packaging their eggs, and selling all those egg cartons.
The company reported earnings before interest and taxes -- operating income -- of $235 million for fiscal year 2015.
This amount doesn't include Cal-Maine's interest expense, interest income, or income tax expense. Those items are applied later en route to arriving at Earnings Before Taxes (EBT), and eventually post-tax profits ("net income").
Wrinkle: some financial companies
For companies where revenue is interest, the notion of "earnings before interest and taxes" is pretty incoherent. For these companies, we can still about their "operating income," but that operating income does include interest.
For example, the traditional commercial banking business model involves borrowing money from depositors and other lenders, and lending money to borrowers like homeowners, businesses, and credit-card holders. Banks earn net revenue when the interest rate they charge borrowers exceeds the interest rate they pay depositors.
Here's Wells Fargo's 2014 annual income statement. Wells earned $47,552 million in interest from its lending, and paid $4,025 million in interest on money it borrowed. Thus, Wells netted $43,527 million on interest. That amount is included in the bank's operating income.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors based in the Foolsaurus. Pop on over there to learn more about our Wiki and how you can be involved in helping the world invest, better! If you see any issues with this page, please email us at firstname.lastname@example.org. Thanks -- and Fool on!
the_motley_fool has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Wells Fargo. The Motley Fool has the following options: short January 2016 $52 puts on Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.