EBIT vs EBT vs PAT: Three Rungs, Two Deductions

Earnings before interest and tax (EBIT) is profit before financing costs and tax. Earnings before tax (EBT) is after financing but before tax. Profit after tax (PAT) is after both. The two deductions between the three rungs are what the lenders take and what the tax authority takes. EBIT compares how well businesses operate, EBT shows what borrowing costs them, and PAT shows what the owners actually keep.

Three profit figures, one twelve month period, and every one of them correct. A reader of an income statement stands in exactly that situation, and the temptation is to decide which of the three is the real profit and treat the other two as working figures on the way to it. The temptation is worth resisting. None of the three is the real one. Each of them stops the arithmetic at a different point on purpose, and the point at which it stops is the whole reason the figure exists.

Underneath the three figures sits a plain observation about businesses. How well a business trades, how much of its money it has borrowed, and what its tax position happens to be are three separate matters that have very little to do with one another. A good notebook printer can be heavily borrowed or carry no borrowing at all, and neither fact says anything about whether it prints notebooks well. So the statement reports profit at three points, and reporting it three times lets a reader hold two of those matters still while looking at the third.

The everyday version is worth holding on to. Everything that follows is the same thought in accounting clothes. Two auto rickshaw drivers work the same route and take the same fares. One bought his rickshaw outright with savings. The other borrowed for his and pays an instalment every month. At the end of the month their fare takings less fuel and repairs are identical. The money that goes home in their pockets is not. The figure before the instalment says which of the two drives the better route. The money that goes home says which one is having the easier month. Both questions are reasonable. The two questions are not the same, and they are not answered by the same number.

Anjani Stationers, an invented notebook printer, ran a year two that produced all three figures. The three amounts are the spine of this guide: operating profit of Rs 41,50,000, earnings before tax of Rs 38,00,000, and profit after tax of Rs 30,00,000, on revenue of Rs 2,70,00,000.

What is EBIT, and what does it refuse to report?

EBIT is the profit a business made from trading, measured after every cost of actually running the operation and before anything else. All the revenue is in it. So is the cost of the paper, the wages of the staff who print and pack, the rent on the shed, the electricity, the depreciation on the machines, and every other cost of doing the work. The cost of the money the business runs on is not in it, and neither is the tax on the result.

The same figure is also called operating profit, and the two names mean the same thing on the same line. Anjani Stationers' EBIT for year two is Rs 41,50,000.

EBIT is the figure that answers how well a business operates, and it earns that role precisely by refusing to say anything about how the business is funded or taxed. That refusal is not a gap in the figure. The refusal is the design. The moment financing is allowed into a profit number, two businesses printing identical notebooks at identical cost will report different profits because one of them borrowed, and any comparison built on that number is measuring the loan rather than the printing.

The refusal buys a great deal. EBIT is measured on the same footing for Anjani Stationers and for the printer down the road, however differently the two are funded. It can therefore say which of them prints notebooks better. Nothing else on the statement below it has that property.

What is EBT, and what has changed by the time it is reached?

EBT, earnings before tax, is EBIT after the finance costWhat a business pays for the money it has borrowed, mainly interest, shown as its own line in the statement of profit and loss. has been taken out and before tax has. EBT is the profit the business made on everything it does, including the consequence of the way it chose to fund itself, with only one claimant left to satisfy.

For Anjani Stationers the arithmetic is one line. EBIT of Rs 41,50,000 less finance cost of Rs 3,50,000 gives EBT of Rs 38,00,000. The Rs 3,50,000 is what a year of borrowing cost the business, and unlike almost every cost above it, the interest does not scale with how busy the year was. The paper bill falls if the presses run less. The interest does not.

EBT is the only one of the three rungs that isolates the cost of a decision the business made about money rather than about operations. EBT is therefore the figure that shows what a chosen capital structureThe mix of borrowed money and shareholders' money that a business runs on. A business with more borrowing and less shareholders' money is said to be more geared. is costing. Set EBIT against EBT and the difference between the two is precisely the price of that decision, stated in rupees, for the year.

Read as a pair, the two rungs answer a question no single figure can. Rs 41,50,000 of trading profit went in at the top; Rs 38,00,000 survived the borrowing. A little over eight per cent of the operating profit went to the lenders, and for Anjani Stationers that is a modest number. Pushed far enough, the same pair of figures tells a very different story. The control below pushes it.

What is PAT, and whose figure is it?

PAT, profit after tax, is EBT after the tax expenseThe total tax charge for the period as reported in the statement of profit and loss. The charge is not the same thing as the tax actually paid in cash during the period. has been taken out. Nothing further is deducted. PAT is the bottom line of the statement, it is what the shareholders' claim is finally measured against, and it is the figure that adds to what the business has accumulated over its life.

Anjani Stationers' EBT of Rs 38,00,000 less a total tax expense of Rs 8,00,000 gives PAT of Rs 30,00,000. The Rs 30,00,000 is the figure that reaches the owner of the business, in the sense that it is the profit the shareholders have a claim on, whether or not any of it is paid out to them during the year.

PAT is the owner's figure and nobody else's, and it is the worst of the three rungs to use for any comparison of how well two businesses operate. Two things have happened to it that have nothing to do with printing notebooks. PAT has been through a financing decision and through a tax computation, and a difference in either one will move PAT while the operation behind it stands completely still.

Notice that this makes PAT both the most important figure on the statement and the most dangerous one. PAT is the most important because it is the only one that describes what the people who put money in actually got. PAT is the most dangerous because it is the figure a rushed reader reaches for, and it is the figure with the most non operating noise in it.

What do the two deductions between the rungs actually represent?

Two claimants, standing in a fixed order, each with a claim on the operating profit before the owner sees any of it. Two claimants are the whole content of the gap between Rs 41,50,000 and Rs 30,00,000, and naming the two claimants is more useful than naming the two lines.

The first claimant is whoever lent the business money. Their claim is the finance cost, and its character is that it was agreed in advance and does not care how the year went. Anjani Stationers owed Rs 3,50,000 of it whether the presses ran flat out or sat idle. The fixedness is the whole reason borrowing changes the shape of a business's results rather than merely their size.

The second claimant is the tax authority. Its claim is the tax expense, and its character is different in an important way: it is computed on what is left after the first claimant has been satisfied. The tax authority does not assess the Rs 41,50,000. The finance cost went out before the tax computation began, so the tax authority assesses something built on the Rs 38,00,000.

The two deductions sit in a fixed order and the second one is computed on what the first one left. The two are therefore not independent of each other and cannot be added up as though they were.

A wedding caterer makes the same shape of journey every season. The takings come in, the ingredients and the staff are paid out of them, and what is left is the caterer's operating profit. Then the instalment on the loan for the vans goes out, whether or not the season was good. Only after that does the tax on the remainder get worked out. Nobody would describe the loan instalment and the tax bill as the same kind of thing, and nobody would compute the tax before knowing the instalment.

Why does one rupee of finance cost not cost the owner a full rupee?

Because the tax authority is standing behind the lender, and when the lender takes a rupee there is a rupee less for the tax authority to assess. So the two claimants share the loss of that rupee between them, and the owner's share of it is smaller than the rupee itself.

Worked through at the illustrative rate of 25 per cent, one extra rupee of finance cost reduces EBT by the full rupee. The tax charge is a quarter of EBT, so the tax charge falls by 25 paise. PAT is EBT less tax, so PAT falls by 75 paise, one rupee less the 25 paise.

The tax computation sits downstream of the financing deduction, so at the illustrative 25 per cent every rupee of finance cost costs the owner 75 paise and costs the tax authority 25 paise. Turned round, it is the same statement: repaying borrowing improves PAT by less than the interest that stops being paid, because part of the saving goes to tax.

The household version lands immediately. Suppose the owner of a small business pays Rs 1,000 more in interest on a loan taken for that business, and suppose the illustrative quarter applies. Profit before tax drops by Rs 1,000. The tax bill drops by Rs 250. The amount the owner actually keeps drops by Rs 750, not Rs 1,000. Nobody has got away with anything: the owner is Rs 750 poorer. But the number to write down is Rs 750, and a reader who writes down Rs 1,000 will get every comparison that follows slightly wrong.

The 75 paise in the rupee is the mechanism that connects the two twins compared below, and it is why the gap between their two PAT figures is smaller than the gap between their two finance costs. With the ratio in hand, that comparison comes apart cleanly.

Which comparison does each rung support, and which does it ruin?

Each rung is measured on a different footing, and comparabilityWhether two figures were measured on the same footing. Setting them side by side establishes something only if they were. Two figures can both be correct and still not be comparable. is entirely a question of whether the two figures being set side by side were measured on the same one. Get that right and the comparison means something. Get it wrong and the comparison measures whichever difference was not held still.

EBIT supports a comparison of operations. Two businesses, two EBIT figures. Financing and tax have been kept out of both, so the difference between them is a difference in trading. The EBIT comparison is the only one of the three that holds both non operating matters still, and it is why anybody comparing businesses professionally starts there.

EBT supports something narrower and often overlooked: a comparison of what funding decisions cost. Setting EBIT against EBT for one business prices its borrowing for the year. Doing the same for two businesses with similar EBIT shows which one is carrying the heavier financing load, without any need to know anything about their loan agreements.

PAT supports the owner's question, and only the owner's question. The owner asks what the year left for the people who put money in. PAT answers that completely and answers nothing else well.

Each rung ruins the comparisons the other two support, so the rung quoted is chosen by what was asked, not by whichever figure came to hand. EBIT quoted to a shareholder asking what the year earned them overstates it by everything the lenders and the tax authority took. PAT quoted to somebody comparing two operations hands over a number containing two differences nobody was asking about.

What do the three rungs look like for Anjani Stationers and for a borrowed twin?

The cleanest way to see what the two deductions do is to hold the operation completely still and change only the borrowing. So here is Tarika Notebooks, an invented business built for exactly that purpose: the same trade, the same scale, and an EBIT of Rs 41,50,000 identical to Anjani Stationers' down to the rupee. The one difference is that Tarika Notebooks funded its presses with a great deal more borrowing, and its finance cost for the year is Rs 20,00,000 rather than Rs 3,50,000.

Follow the two down the rungs. Both start at Rs 41,50,000. Anjani Stationers loses Rs 3,50,000 to the lenders and arrives at EBT of Rs 38,00,000. Tarika Notebooks loses Rs 20,00,000 and arrives at EBT of Rs 21,50,000. On the illustrative 25 per cent, Tarika Notebooks' tax is Rs 5,37,500 and its PAT is Rs 16,12,500. Anjani Stationers' actual tax charge was Rs 8,00,000 and its PAT is Rs 30,00,000.

From the same Rs 41,50,000 of operating profit, the owner of one business keeps Rs 30,00,000 and the owner of the other keeps Rs 16,12,500, and not one rupee of that difference came from operating better or worse. The two PAT figures read on their own say the first business is nearly twice the second. The two EBIT figures say they are indistinguishable. Both readings are correct about what they measure.

One honest wrinkle, and it matters. Anjani Stationers' Rs 30,00,000 uses its real tax charge of Rs 8,00,000. Tarika Notebooks' figure uses the illustrative quarter. The two PAT figures are therefore not struck on exactly the same tax footing. Put Anjani Stationers on the illustrative quarter too and its tax would be Rs 9,50,000 and its PAT Rs 28,50,000. On that consistent footing the two keep Rs 28,50,000 and Rs 16,12,500, a gap of Rs 12,37,500. The gap is exactly Rs 16,50,000 of extra finance cost at 75 paise in the rupee. The mechanism from the previous block closes the comparison to the rupee.

Why is Anjani Stationers' tax not a quarter of its profit before tax?

Because a business's tax charge is worked out under tax rules rather than by applying one rate to the accounting profit, and the two do not land on the same number. A single clean rate makes the mechanism visible, and that is the only reason an illustrative statutory rateThe headline rate of tax set in law for a category of taxpayer, before any of the adjustments that make a particular business's actual charge differ from it. of 25 per cent stands in for the real one throughout. The rate that would actually apply comes from the tax authority.

Hold the two side by side for Anjani Stationers. A quarter of EBT of Rs 38,00,000 is Rs 9,50,000. The tax expense actually reported is Rs 8,00,000. The effective tax rateThe tax charge for the period divided by the profit before tax, expressed as a percentage. The effective rate is a result read off the statement, not a rate anybody sets. is therefore Rs 8,00,000 over Rs 38,00,000. The division gives 21.1 per cent rather than 25 per cent, and the gap is Rs 1,50,000.

The gap between a flat rate applied to profit before tax and the tax charge actually reported is normal, it has specific identifiable causes, and it is the reason PAT is a poor place to look for anything except what the owner kept. What makes up Anjani Stationers' Rs 1,50,000 gap is a separate subject with its own moving parts, covered separately. Three things matter. A gap is to be expected, the effective rate is computed rather than the statutory one assumed, and a rate is never reversed out of PAT to work out what EBT must have been.

Five settings, written out, show the whole range. At a finance cost of Rs 0 the whole Rs 41,50,000 reaches the tax computation: tax of Rs 10,37,500 and PAT of Rs 31,12,500. At Rs 3,50,000, the actual year, EBT is Rs 38,00,000 and simplified PAT is Rs 28,50,000 against the Rs 30,00,000 reported. At Rs 10,00,000, EBT is Rs 31,50,000 and PAT is Rs 23,62,500. At Rs 20,00,000, where Tarika Notebooks sits, EBT is Rs 21,50,000 and PAT is Rs 16,12,500. At Rs 30,00,000, EBT is Rs 11,50,000 and PAT is Rs 8,62,500, less than a third of what the owner kept at the first setting. EBIT reads Rs 41,50,000 at every one of those five points, and the operating profit did not move a rupee across the whole range.

What do a lender, an analyst and a shareholder each do with these three?

The three reach for different rungs, and each of them would consider the other two rungs the wrong figure for their purpose. Watching them do it is the fastest way to fix the rule in place.

A lender looks at the top two rows together. The finance cost has to be paid out of the operating profit, so the lender wants to know whether the operating profit is comfortably larger than the finance cost. Divide EBIT by finance cost and Anjani Stationers gives Rs 41,50,000 over Rs 3,50,000, or 11.9 times over. Tarika Notebooks gives 2.1 times. The ratio is often called interest coverOperating profit divided by finance cost: how many times over the profit from trading covers the cost of the borrowing for the same period., and it is why a lender cares about EBIT at least as much as any shareholder does. The lender's own claim has already been taken out of PAT, so PAT is nearly useless to the lender.

An analyst comparing businesses starts at EBIT and stays there for the operating question, then goes to EBT and PAT separately to see what financing and tax did. The discipline is to treat the three as three separate readings rather than one ladder to be summarised, and never to let a financing difference enter a sentence about operations.

A shareholder, and equally the person who runs the business as its owner, reads PAT. PAT is the only rung measured after everyone else has been satisfied. Anjani Kulkarni, who runs Anjani Stationers, cannot spend EBIT. The Rs 3,50,000 has gone to lenders and the Rs 8,00,000 has gone to tax, and the Rs 30,00,000 is what remains available to the business and to its shareholders.

The operation is what changes hands when a business is sold, and the borrowing and the tax position usually do not come with it, so anybody buying a business reads EBIT hardest of all. That is the sharpest argument for why the top rung exists. A buyer will fund the business their own way and will have their own tax position, so the seller's finance cost and tax charge describe arrangements that are about to be replaced. The operation survives the change of hands, and EBIT is the figure that describes it.

What goes wrong when PAT is used as an operating score?

Something quiet, entirely arithmetic, and very hard to spot once it has left the document it was built in. Nobody misstates anything. A ranking gets built out of a figure that moves for reasons the ranking claims not to be about, and the ranking then travels much further than the person who built it.

The document itself is ordinary. PAT growth is easy to compute from published figures and sounds like an achievement, so a short internal note ranks three notebook printers on it. Tarika Notebooks tops it: its PAT went from Rs 8,62,500 to Rs 16,12,500, a rise of 87.0 per cent. Kesari Paper Works, an invented printer with steady borrowing, comes second on 7.5 per cent. Anjani Stationers comes last at minus 21.1 per cent, its profit having gone from Rs 38,00,000 to Rs 30,00,000. The note calls Tarika Notebooks the standout operator of the three.

Now look at the column nobody opened. Tarika Notebooks repaid part of its borrowing, and its finance cost fell from Rs 30,00,000 to Rs 20,00,000 over those two years. Its EBIT was Rs 41,50,000 in both years. Not a rupee of that 87.0 per cent came from operating better. Rs 10,00,000 less finance cost, at 75 paise in the rupee, is Rs 7,50,000 more PAT, and Rs 7,50,000 is the entire rise. The whole of the winner's margin of victory is a financing event wearing an operating label.

Which rung should be quoted, in one table?

The whole distinction holds beside any statement, not only this one. The left column is the question as somebody would actually ask it out loud. The middle column is the rung. The right column is what it gives for Anjani Stationers in year two, so the shape of the answer is visible rather than abstract.

Two habits make the table stick. The first is to write the rung's name beside every profit figure copied out, every time, even when it feels unnecessary. The moment a number leaves the statement it came from, nobody can tell which rung produced it, and every reader will assume it was the one they had in mind. The second is to look at EBIT before PAT rather than after. Then, when PAT surprises, whether the operation moved is already known. Most of the mistakes above are committed by readers who met the bottom line first and never went back up.

Anjani Stationers Private Limited, Tarika Notebooks, Kesari Paper Works and Anjani Kulkarni are invented.
Educational material. Not advice on any investment, tax, budget or market position.