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EBIT (earnings before interest and taxes) and EBITDA (earnings before interest, taxes, depreciation, and amortization) are two ways to measure a business’s profitability. While the two appear to be similar, they differ in critical ways.Both EBIT and EBITDA start with net income and add back interest and taxes. However, EBITDA also adds back depreciation and amortization, while EBIT does not. In practice, EBITDA tells you the approximate cash flow generated by a company’s operations. EBIT, on the other hand, tells you the approximate amount of operating income generated by a company. Here’s what you need to know about EBIT vs. EBITDA, how they are similar and different, and what they can tell you about your business.
What is EBITDA?
EBITDA stands for earnings before interest, taxes, depreciation, and amortization. The purpose of EBITDA is to show how profitable a company is before capital expenditures, capital structure, and taxes are taken into consideration. The reason for backing these costs out of net income is that managers often have little control over these variables, so they can distract analysts and investors from what the company is doing well. EBITDA is not an official GAAP (generally accepted accounting principles) calculation because it removes the effects of all of those variables, which are real expenses. However, from an analyst’s or investor’s viewpoint, there are good reasons to not include them when understanding a business. Let’s take a look at why.Interest: This refers to interest on debt, including any type of business loans. The reason EBITDA excludes interest is that how much debt a company takes on will depend on the financing structure of a company. Different companies have different capital structures and, as a result, different interest expenses. To better compare the relative performance of different companies, EBITDA adds interest paid on debt back to net income. Taxes: Because taxes vary by region, two companies with identical sales numbers could pay significantly different amounts depending on where they are located. Therefore, taxes do not illustrate a company’s financial performance or revenue potential. When comparing the performance of two different companies, it’s logical to remove their tax burdens.Depreciation: Depreciation involves spreading out the cost of a tangible asset over the course of its useful life. For many companies, depreciation is a real cost that can’t be avoided. However, EBITDA adds this non-cash expense back to net income because it depends on the historical investments the company has made, not on its current operating performance. Amortization: Amortization is essentially the same thing as depreciation, but instead of accounting for the decline of a tangible asset’s value over time, it accounts for the decline of an intangible asset’s value. Intangible assets include trademarks, patents, copyrights, and computer software. Here again, some companies have more amortization costs than others. While it’s a real expense, it depends on the historical investments the company has made, not on its current operating performance.
Calculating EBITDA
There are two widely used methods for calculating EBITDA.Option 1: Net income + interest + taxes + depreciation + amortization = EBITDAOption 2:Operating Profit + Depreciation + Amortization = EBITDAIf you’re calculating EBITDA from a company’s financial statements, you’ll find net income, interest expense, and taxes on the income statement. Depreciation and amortization may be listed separately as items on the income statement or on the cash flow statement. In some cases, they may be bundled into operating expenses, which means you can usually find them in a note accompanying the accounts.
What is EBIT?
EBIT stands for earnings before interest and taxes. EBIT is used to analyze the performance of a company's core operations without tax expenses and the costs of the capital structure (debt) influencing profit. While both taxes and interest on debt are real cash expenses, they’re not directly generated by the company’s core business operations. By stripping out interest and taxes, EBIT reveals the underlying profitability of the business.
Calculating EBIT
There are two main ways to calculate a company’s EBIT.Option 1: Net income + Interest Expenses + Taxes = EBITOption 2:Sales Revenue — Cost of Goods Sold — Operating Expenses = EBITSomething to note: There is a subtle difference between the two above calculation methods. EBIT calculated using the second method is always equal to operating income as defined under GAAP. However, EBIT calculated using the first method differs from operating income if net income includes non-operating income and/or non-operating expenses.If you know a company’s EBITDA, yet a third way to calculate EBIT is to take the EBITDA number and subtract depreciation and amortization.
Comparing EBIT and EBITDA
EBIT and EBITDA have similarities, as well as some distinct differences. Here’s a closer look.
Similarities
Both EBIT and EBITDA are alternative methods to measure a company’s financial performance during a given reporting period (e.g., quarterly or annually). Neither are GAAP-approved metrics, and, thus, are not part of a firm’s income or cash flow statements. Instead of looking solely at net income, both EBIT and EBITDA remove certain costs that can distract from how well a company is actually doing. With both metrics, you remove the effect of interest and taxes by adding them back to a company’s net income.
Differences
The main difference between EBIT and EBITDA is that EBITDA adds depreciation and amortization back to net income, while EBIT does not. Therefore, EBITDA will usually be higher than EBIT simply because it takes non-cash expenses into account.These performance metrics also measure two different things: An EBIT analysis will tell you how well a company can do its job, while an EBITDA analysis can help you estimate what kind of cash spending power a business can have.EBITDA can be more useful than EBIT if a firm has heavy capital investments, since depreciation and amortization expenses can make the company’s operating budget look a lot less healthy than it actually is. Here’s a side-by-side comparison of EBIT vs. EBITDA:
The advantage of using the EBIT model is that analysts often consider taxes and financing third-party expenses. These costs are important, since no company can stay in business if it can’t pay its taxes or make interest payments on debt. But when looking only at a company’s net income, taxes and interest can skew market performance. However, there are some downsides to using this formula. By leaving out the cost of servicing debt, EBIT can potentially give a misleading picture of a firm's financial strength. A company with a high debt load could report the same EBIT as a company with very little debt, yet the company with high debt might fail if it experienced a sudden drop in sales revenue.Here’s a closer look at the pros and cons of EBIT:
Benefits of EBIT
Cons of EBIT
Shows how well a company’s products and services generate profits
Does not conform to GAAP
Helps investors compare companies in the same sector with different tax obligations and capital structures
Can give a misleading impression of a company’s financial resilience
Easier to calculate than EBITDA using the income statement
Companies with high capital expenditures may have a significant difference between EBIT and actual cash flow
What Does a High EBITDA vs Low EBIT Mean?
A company that has a high EBITDA and a low EBIT has high depreciation and/or amortization expenses. This means it likely purchased a large number of fixed assets (tangible or intangible) with cash, rather than with financing, and is gradually writing down the value of those assets over time. As a result, the company has increased depreciation costs, but low interest charges. EBIT excludes the interest charges but not depreciation and amortization costs whereas EBITDA eliminates both. This will result in an EBITDA that is higher than EBIT.
EBIT vs EBITDA Examples
A small app company has a net income of $200,000 after operating expenses are accounted for. It pays $70,000 in taxes and $90,000 in interest on debt. It has a few patents it’s amortizing ($5,000), as well as annual depreciation costs for its computer hardware ($50,000). EBIT Example:Net Income + Taxes + Interest = EBIT$200,000 + $70,000 + $90,000 = EBIT$360,000 = EBITEBITDA Example:Net income + taxes + interest + depreciation + amortization = EBITDA$200,000 + $70,000 + $90,000 + $50,000 + $5,000= EBITDA$385,000 = EBITDAFor this company, EBITDA is higher than EBIT, so the company might prefer to highlight EBITDA as a performance metric.
The Takeaway
When comparing EBIT vs. EBITDA, the key difference is that EBITDA adds back in depreciation and amortization to net income, whereas EBIT does not. As a result, EBIT essentially looks at a company’s approximate amount of income generated, while EBITDA provides a snapshot of a company’s overall cash flow. EBIT and EBITDA each look at profits in a slightly different way. Depending on the company’s characteristics, one or the other may be more useful. If you’re looking to woo an investor or apply for a small business loan, a lender or analyst may use both measures to gauge your company’s financial performance and ability to generate income from its operations.
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Frequently Asked Questions
When would you use EBIT instead of EBITDA?
Is EBITDA always higher than EBIT?
Is EBIT the same as operating income?
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About the Author
Lauren Ward
Lauren Ward is a personal finance expert with nearly a decade of experience writing online content. Her work has appeared on websites such as MSN, Time, and Bankrate. Lauren writes on a variety of personal finance topics for SoFi, including credit and banking.
