Companies often make investments in corporate or government bonds. The company must account for these bond investments in a specific way that includes amortizing a portion of their cost over time for bonds bought at a premium, and recording interest income. These items also factor into the calculation of earnings before interest and taxes (EBIT).
1. Locate an income statement for the subject company. Start with the net income. The EBIT figure is calculated by removing, or adding back, certain financial statement components to provide a clearer picture of the company's operating performance.
2. Isolate the amount of interest income the company received, including interest income received from bond payments. Subtract this amount from any interest expense paid. Adjust net income by the net effects of interest. The intention is to treat net income as if interest income and expense did not exist, so subtract any net interest income, or add back any net interest expense.
3. Add taxes paid back to net income. Because companies can have different tax strategies and use slightly different tax rates in their financial statement calculations, the removal of taxes helps further clarify the company's financial performance from operations.
4. Evaluate the resulting EBIT. If a company has income or expenses that are not related to the business, other than those from investments or the cost of borrowing, you might prefer the top-down EBIT approach. Start with net sales, and subtract cost of goods sold. Then subtract selling, general and administrative (SG&A) expenses. These should encompass only the expenses directly involved in operating the business. Extract any non-operating expenses recorded in SG&A, such as restructuring or re-organization costs or pension contributions.
- Many analysts and investors also look at a company from an earnings before interest, taxes, depreciation and amortization (EBITDA) perspective. This removes all effects of financing and investments, including the amortization from bonds the company holds. This allows more direct comparison of companies based on operating results, without involving the extra complexity of debt and investments.
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