EBIT vs EBITDA | Top Differences | Examples | Calculation

EBIT is earnings before interest and taxes which is the Operating Income 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.read more) 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, EBITDA 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.

Colgate EBIT

In this article on EBIT vs. EBITDA, we look at its differences & usage in depth.

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.read more – 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. read more 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 depreciation 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. EBITDA 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.

Importance of EBITDA

source: Verizon Annual Report

As seen below – EBITDA = EBIT (Operating Income) + Depreciation and Amortization.

EBIT vs EBITDA - Verizon

source: Verizon Annual Report

Also, note that EBITDA most often used for evaluating valuation ratios (EV/EBITDA) against calculating revenue and enterprise value.

EBIT vs EBITDA – Key Differences


EBIT EBITDA
  • EBITDA illustrates earnings prior to any amortization or depreciation.
  • For reconciling EBIT with GAAP-responsive figures, SEC usually recommends leveraging net income for calculations as identified from the operating statements.
  • EBITDA is most commonly used by highly capital-intensive and leveraged companies that need significant depreciation schemes like those required with telecommunications or utility companies. Since these companies have significant debt interest payments and elevated depreciation rates, they most often leave them with poor earnings. In addition, negative earnings often make valuation difficult. Hence analysts instead depend on EBITDA measure for identifying total earnings really accessible for the payment of a debt.
  • EBIT determines the firm’s profit that comprises of all the expenditures, leaving only tax and interest expense.
  • EBITDA determines a company’s real operating performance devoid of any concealed expenses such as amortization, depreciation, tax, and interest.
  • It represents operating results on an accumulation basis.
  • Calculation: EBIT = revenue – operating expenditures.
  • Calculation: EBITDA = revenue – operating expenditures (leaving amortization and depreciation).

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.read more (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.read more, 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 expenseread more, 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

Company A Company B
Revenue 5,500,000 5,250,000
Cost of Goods (3,555,000) (3,470,000)
Gross ProfitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services.read more 1,945,000       35.4% 1,780,000          33.9%
Selling, General &
Administrative Expenses (1,550,000) (1,370,000)
Operating Income 395,000           7.2% 410,000           7.8%
Interest Expenses (30,000) (70,000)
Taxes (65,000) (65,000)
Net Income 300,000             5.5% 275,000            5.2%
Net Income 300,000 275,000
Interest Expense 30,000 70,000
Taxes 65,000 65,000
Depreciation + Amortization 110,000 170,000
EBITDA 505,000          9.2% 580,000         11.1%

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.read more 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.

Colgate - Finding Depreciation for EBITDA

A further look at Colgate’s accounting disclosures reveal that Depreciation that is attributable to manufacturing operations is included in 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.

EBITDA - Depreciation

The best and the easiest way to find Depreciation and Amortization is to look at the cash flow statementCash Flow StatementStatement of Cash flow is a statement in financial accounting which reports the details about the cash generated and the cash outflow of the company during a particular accounting period under consideration from the different activities i.e., operating activities, investing activities and financing activities.read more. Cash Flow from Operations includes the Depreciation and amortization figures.

Colgate - Finding Depreciation for EBITDA - Part 2

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.read more) 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
Revenue $200 $200
Cash Expenses $180 $180
Depreciation and
Amortization $0 $20
EBIT $20 $0
EBITDA $20 $20

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.read more. 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 - Services Companies

source: ycharts

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 Salesread more 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. read more that leads to high depreciation and amortization figures.

EBIT vs EBITDA - Capital Intensive Companies

source: ycharts

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 Ratio)
  • 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.

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 Drawbacks


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Comments

  1. Jagan says

    Hi,

    If a company has a negative EBITDA, then it will be obvious that EBIT will also be negative?

    Is this the right inference

    • Dheeraj Vaidya says

      Yes, you are right. EBITDA = EBIT + D&A. D&A can be either 0 or positive. Hence, if EBITDA is negative, then EBIT must be negative.

  2. Swapnil says

    Your articles are well written and clarify basic concepts well.

  3. Adebisi says

    God bless you. Well done!

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