EBIT is earnings before interest and taxes which is the Operating IncomeOperating IncomeOperating Income, also known as EBIT or Recurring Profit, is an important yardstick of profit measurement and reflects the operating performance of the business. It doesn’t take into consideration non-operating gains or losses suffered by businesses, the impact of financial leverage, and tax factors. It is calculated as the difference between Gross Profit and Operating Expenses of the business. generated by the business whereas, EBITDA is earnings before interest, taxes depreciation and amortization which represents the entire cash flow generated from operations of a business.
EBIT vs EBITDA
What is Operating Profit? Let us have a look at the Income Statement of Colgate above. Is it EBIT (Earnings Before Interest and TaxesEarnings Before Interest And TaxesEarnings before interest and tax (EBIT) refers to the company's operating profit that is acquired after deducting all the expenses except the interest and tax expenses from the revenue. It denotes the organization's profit from business operations while excluding all taxes and costs of capital.) or EBITDA (Earnings Before Interest Taxes Depreciation & Amortization)?
The operating profit is EBIT. EBIT defines any company’s profit, including all expenditures just leaving income tax and interest expenditures. However, EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business's performance with that of its competitors. measure is good to be used for analyzing and comparing profitability between firms and businesses as it removes the impacts of accounting and financing decisions.
In this article on EBIT vs. EBITDA, we look at its differences & usage in depth.
- EBIT vs EBITDA – Definition
- EBIT vs EBITDA – Key Differences
- EBIT vs EBITDA Examples
- Calculation of EBITDA of Colgate
- EBIT vs EBITDA – Capital Intensive Firms and Services Companies
- Key Points to Note about EBITDA
- EBITDA Drawbacks
EBIT vs EBITDA – Definition
In finance and accounting, earnings before interest and taxes (EBIT) defined as any company’s profit, including all expenditures just leaving income tax and interest expenditures. It is defined by the formula:
EBIT Formula = operating revenueOperating RevenueOperating revenue is defined as revenue earned by an individual, corporation, or organization from the core activities that they undertake on a regular basis. There are several methods to earn revenue, but operational revenue is earned by the core business activities that the organization undertakes in its daily operations. – operating expenses or OPEX
If the company doesn’t have non-operating incomeNon-operating IncomeNon-Operating Income, also called Peripheral Income, is the capital amount that a business earns from non-core revenue-generating activities. The examples include profits/losses from a capital asset sale or Foreign Exchange Transactions, Dividend Income, Lawsuits losses, & Asset Impairment losses, etc. for calculation purposes, then alternatively operating income may be used similar to operating profit and EBIT.
Earnings before interest, taxes, depreciation, and amortization or EBITDA, an accounting term calculated through the firm’s net earnings, prior to interest, taxes, expenses, amortization and depreciationDepreciationDepreciation is a systematic allocation method used to account for the costs of any physical or tangible asset throughout its useful life. Its value indicates how much of an asset’s worth has been utilized. Depreciation enables companies to generate revenue from their assets while only charging a fraction of the cost of the asset in use each year. that are deducted, being a substitute for a firm’s existing operating profitability. It is defined by the formula:
EBITDA = EBIT or operating profit + depreciation expenditure + amortization expenditure
Or, EBITDA = Total profit + Amortization + Depreciation + Taxes + Interest
Adding the company’s overall expenditures due to amortization and depreciation back to its EBIT.
EBITDA is basically net income added to amortization, depreciation, taxes, and interest. EBITDAEBITDAEBITDA refers to earnings of the business before deducting interest expense, tax expense, depreciation and amortization expenses, and is used to see the actual business earnings and performance-based only from the core operations of the business, as well as to compare the business's performance with that of its competitors. measure is good to be used for analyzing and comparing profitability between firms and businesses as it removes the impacts of accounting and financing decisions.
Verizon provides Consolidated EBITDA as a non-GAAP measure. Verizon management believes that these measures are useful for investors in evaluating the profitability and operating performance of the company.
source: Verizon Annual Report
As seen below – EBITDA = EBIT (Operating Income) + Depreciation and Amortization.
source: Verizon Annual Report
Also, note that EBITDA most often used for evaluating valuation ratios (EV/EBITDA) against calculating revenue and enterprise valueEnterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover..
EBIT vs EBITDA – Key Differences
EBIT vs EBITDA Examples
EBIT vs EBITDA – Example 1
Suppose there’s a construction company having $70,000 revenue last year. But, the firm’s operating expenditures were recorded at $40,000. Therefore, EBIT = $70,000 – $40,000 = $30,000.
The expenditures include administrative, general, selling, cost of goods soldCost Of Goods SoldThe Cost of Goods Sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. (COGS), utilities & rent, salaries, amortization, and depreciation.
- Add any depreciation expenses.
Now, extending the same example for calculating EBITDA with key assumptions including, working lifetime expectation for the asset of 10 years. Suppose the machinery purchased by the company some time back had their consolidated value of $30,000 with a working life of say 10 years. In such a case, upon assuming straight-line or linear depreciation, the machinery would together depreciate by $30,000/10 = $3,000 per year.
- Add any amortization expenses.
Amortization is linked to depreciation; however, it isn’t the same technique. Amortization denotes the expenditures witnessed from the strategic acquisition of key intangible assets any time over their complete life, while depreciation used for tangible assets. Typically, amortization expenditures are recorded in line with depreciation expenditures on any company’s P&L or cash flow statements. Sum up any listed amortization expenditures for obtaining and recording one unique value.
- For instance, assume that some time back, a company expended $2,000 for obtaining the rights for some famous Sufi song to be used in the commercials. Suppose this money purchased the song rights for say five years.
- Thus, Amortization expense = $2,000/5 years = $4, 00/year
Now, calculating EBITDA using the formula,
EBITDA = EBIT + amortization + depreciation
Adding back the overall expenditures due to amortization and depreciation to the firm’s EBIT. EBITDA is defined as the calculation of net earnings prior to amortization, depreciation, taxes, and interest. As amortization and depreciation were previously subtracted for EBIT calculationEBIT CalculationEBIT is a profitability tool used to measure the operating Profits of a Company. You can calculate it either by, EBIT = Gross Sales – Company Expenses & Cost of Goods Sold, Or, EBIT = Total Profit + Interest + Taxes., one must add them again to find EBITDA.
- In the above example about the construction company, let’s believe that the amortization and depreciation expenses identified earlier are just the costs incurred by the company (actually, one might find it crucial to add numerous depreciation or/and amortization expenditures to arrive at the net value).
- For this case, let’s evaluate EBITDA through the formula, EBITDA = amortization + depreciation + EBIT. $400 + $3000 + $30,000 = $33,400. Hence, the company’s EBITDA calculated to be $33,400.
EBIT and EBITDA – Example 2
Suppose a retail firm delivers $100 million of revenue and witnesses $40 million of product expense and $20 million of operating expenditures. Amortization and depreciation expenditure recorded at $10 million, delivering net profit from operations of $30 million. Further, the interest expenditure is $5 million that makes $25 million of earnings before taxes. Assuming a tax rate of 20%, net income becomes $20 million posts $5 million of taxes that are deducted from the company’s pretax income. Employing EBITDA formulaEBITDA FormulaEBITDA is Earnings before interest, tax, depreciation, and amortization. Its formula calculates the company’s profitability derived by adding back interest expense, taxes, depreciation & amortization expense to net income. EBITDA = net income + interest expense + taxes + depreciation & amortization expense, let’s sum operating profit with depreciation, amortization expenditure for arriving at the EBITDA equals to $40 million ($30 million added to $10 million).
EBIT and EBITDA – Example 3
In the above example, company B has illustrated better EBITDA measure compared to company A despite having comparatively smaller top line growth.
EBITDA is defined by cash flow from operationsCash Flow From OperationsCash flow from Operations is the first of the three parts of the cash flow statement that shows the cash inflows and outflows from core operating business in an accounting year. Operating Activities includes cash received from Sales, cash expenses paid for direct costs as well as payment is done for funding working capital. that minimizes the impact of tax policies, financing, and accounting on stated profits.
Calculation of EBITDA of Colgate
Below is the snapshot of the Income Statement of Colgate. As we saw earlier, the Operating Profit reported is EBIT (Earnings Before Interest and Taxes). If you look at the Income Statement closely, you will not find line Depreciation & Amortization line item.
A further look at Colgate’s accounting disclosures reveal that Depreciation that is attributable to manufacturing operations is included in the Cost of SalesCost Of SalesThe costs directly attributable to the production of the goods that are sold in the firm or organization are referred to as the cost of sales. (before the Gross Profit). And the remaining of the depreciation is included in the SG&A expense or Selling General and Admin expense.
The best and the easiest way to find Depreciation and Amortization is to look at the cash flow statementCash Flow StatementA Statement of Cash Flow is an accounting document that tracks the incoming and outgoing cash and cash equivalents from a business.. Cash Flow from Operations includes the Depreciation and amortization figures.
EBITDA (2015) = EBIT (2015) + Depreciaton & Amortization (2016)
EBITDA 2015 = 2,789 + 449 = $3,328 million
Likewise, EBITDA (2014) = 3,557 + 442 = $3,999 million
EBIT vs EBITDA – Capital Intensive Firms and Services Companies
Let us look at a typical Services Company EBIT/EBITDA and Capital Intensive Firm (manufacturing firm) EBIT/EBITDA
Services companies do not have a large asset base. Their business model is dependent on Human Capital (employees). Due to this depreciation and amortization in Servies Companies in generally non-meaningful. However, Manufacturing Companies (or Capital Intensive companiesCapital Intensive CompaniesCapital intensive refers to those industries or companies that require significant upfront capital investments in machinery, plant & equipment to produce goods or services in high volumes and maintain higher levels of profit margins and return on investments. Examples include oil & gas, automobiles, real estate, metals & mining.) invest heavily in its set up and are dependent on the investments in assets to manufacture goods. Therefore, with a higher asset base, its depreciation and amortization are relatively higher.
Consider the example below –
|Items||Service Company A||Manufacturing Company B|
Both the companies have equal EBITDA while the company’s EBIT is $20 billion, but the company’s B EBIT is a mere $0 billion.
EBIT vs. EBITDA of Infosys – Service Companies
The difference between EBIT margin and EBITDA margin can tell us the relative amount of depreciation and amortization in the Income StatementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.. We note from the graph below that the difference between EBIT Margin and EBITDA Margin for Infosys is approximately 1.24% (27.34% – 26.10%). This is expected from a services firm as they operate as an Asset Light model.
EBIT vs EBITDA of Exxon (Capital Intensive Firm)
Now let us compare the above graph with that Exxon. Exxon is an Oil & Gas company (highly capital intensive firm). As expected, we note that the difference between EBIT Margin and EBITDA marginEBITDA MarginEBITDA Margin is an operating profitability ratio that helps all stakeholders of the company get a clear picture of the company's operating profitability and cash flow position. It is calculated by dividing the company's earnings before interest, taxes, depreciation, and amortization (EBITDA) by its net revenue. EBITDA Margin = EBITDA / Net Sales is very high – approximately 8.42% (13.00% – 4.58%). This is because of heavy investments in Property Plant and EquipmentProperty Plant And EquipmentProperty plant and equipment (PP&E) refers to the fixed tangible assets used in business operations by the company for an extended period or many years. Such non-current assets are not purchased frequently, neither these are readily convertible into cash. that leads to high depreciation and amortization figures.
Key Points to Note about EBITDA
EBITDA Data must be used responsibly
- Never use EBITDA as a key technique for determining the company’s financial strength. EBITDA is expected to have some utility in a financial study. For example, it’s a simpler technique for identifying the amount of money that the company needs to remunerate for the remaining debts over the short-term – suppose a company has $2,000 for interest payments, however, $3,000 as EBITDA, it’s observed that the firm has enough money to settle its debt. But, as EBITDA doesn’t take into account key expenditures and since it can be easily altered, hence it’s foolish to just use it is the sole measurement of the company’s strength. (also look at Interest Coverage RatioInterest Coverage RatioThe interest coverage ratio indicates how many times a company's current earnings before interest and taxes can be used to pay interest on its outstanding debt. It can be used to determine a company's liquidity position by evaluating how easily it can pay interest on its outstanding debt.)
- EBITDA doesn’t actually prove to be an accurate indicator of if any company is making money or losing money. In reality, it’s actually possible for any company to illustrate positive EBITDA while having negative free cash flows. Therefore, EBITDA can be used to falsely make any company appear much better than it truly is.
A company’s EBITDA shouldn’t be purposefully manipulated.
- EBITDA may be altered through corrupt accounting methodsAccounting MethodsAccounting methods define the set of rules and procedure that an organization must adhere to while recording the business revenue and expenditure. Cash accounting and accrual accounting are the two significant accounting methods.. For instance, as amortization and depreciation are evaluated fairly in detail (through experience, estimates, and projections), it’s likely to alter the company’s EBITDA through alterations with its amortization and depreciation plans. However, amortization and depreciation are non-cash expenditures (cash has previously been swapped for the amortizing/ depreciating assets). However, they are present for some reason. Finally, intangible assetsIntangible AssetsIntangible Assets are the identifiable assets which do not have a physical existence, i.e., you can't touch them, like goodwill, patents, copyrights, & franchise etc. They are considered as long-term or long-living assets as the Company utilizes them for over a year. perish and equipment flops. After this takes place, extremely real cash expenditures take place.
- As a practical case of EBITDA management, Worldcom capitalized items that should have been expensed. Capitalization increased the depreciation and resulted in higher profit (due to reduced expenses) and also reported higher EBITDA keeping the analysts happy.
Never use EBITDA multiple to misrepresent any firm.
- EBITDA is not a reliable multiple for determining any company’s financial health as it can be easily altered to post a rosy picture about any company that is enough to misguide the lenders and investors. For example, in some businesses, the limit for taking loans is determined by calculating the EBITDA percentage, therefore, by controlling the firm’s EBITDA, business holders can easily deceive lenders into offering huge loans as against under normal lending conditions.
- Fake practices such as these are crafted to fraud a firm’s stakeholders are corrupt and may even be unlawful.
EBIT vs EBITDA Video
- EBITDA is an adjusted figure that enables healthy decision-making capabilities for what must be and what must not be taken while performing the calculation. Further, it also signifies that firms often alter the elements involved while performing EBITDA calculation across different reporting periodsReporting PeriodsA reporting period is a month, quarter, or year during which an organization's financial statements are prepared for external use uniformly across a period of time in order for the general public and users to interpret and evaluate the financial statements..
- EBITDA was first introduced with leveraged buyouts during the 1980s, while it was employed to identify the capability of any company to successfully service the entire debt. With the passage of time, EBITDA became extremely popular among industries having exclusive assets that required write down over longer time periods. At present, EBITDA is most commonly used by several companies, particularly belonging to the tech segment, although it stays warranted.
- The most common delusion comprises of EBITDA equivalent to the cash earnings. However, EBITDA forms a good evaluator of profitability; however, not cash flows. EBITDA even forgets the total cash needed for funding the working capital as well as old equipment replacement that may be notable. Thus, EBITDA is frequently used as an accounting trick for making any company’s earnings appear lucrative to the investors. While using this technique, it is important that stockholdersStockholdersA stockholder is a person, company, or institution who owns one or more shares of a company. They are the company's owners, but their liability is limited to the value of their shares. also emphasize on other key performance metrics for being sure that the company isn’t hiding something under the EBITDA metric.