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EBITDA and revenue are two key metrics of a company’s health and financial performance. Revenue is the amount of money a company brings in from its operations, while EBITDA is what revenue is left after subtracting the cost of goods sold and some other operational expenses. Analyzing revenue and EBITDA serves different purposes for a small business. Read on to learn why each metric is important, the difference between revenue and EBITDA, and how to calculate these numbers.
What Is EBITDA?
EBITDA is a measure of profitability that stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. In other words, it’s the earnings that a business has generated prior to any debt interest expenses, tax payments, and depreciation/amortization costs of the business.While interest, taxes, depreciation, and amortization are expenses that get considered in other financial metrics, EBITDA doesn’t factor these values in because they are outside of management’s operational control. By adding these values back to net income (gross business income minus all business expenses), many analysts believe that EBITA is a better way to measure how well a business is run.EBITDA is not required to be included in an income statement, but if it were, it would appear a few lines below the revenue line item. A business’s EBITDA number will always be lower than its revenue figure, as certain operating expenses are deducted from it. Recommended: What Is EBIDA?
What EBITDA Does
EBITDA is often used by analysts to assess a business’s financial performance and operational efficiency. Because EBITDA adds back interest, taxes, depreciation and amortization (expenses that don’t directly reflect a company’s decisions) to a company’s net income, it shines a light on a business’s ability to generate cash flow from its operations.Depreciation and amortization, for example, are non-cash expenses – they’re considered costs on an income statement but do not require the actual outlay of money. While interest and taxes do require payment in cash, they are non-operating expenses not directly affected by the business’s primary activities.EBITDA may be calculated by investors or when you’re applying for a business loan to estimate how well your company will be able to pay its bills and maintain or increase net income.
How EBITDA Is Calculated
One of the most common ways to calculate EBITDA is to start with net income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation and amortization.
EBITDA Formula
Net income + Taxes Owed + Interest + Depreciation + Amortization = EBITDAAn alternate way to calculate EBITDA is to start with operating income. Operating income is also referred to as operating profit or EBIT (Earnings Before Interest and Taxes). It’s the amount of revenue left after deducting the direct and indirect operating costs from sales revenue. If you add depreciation and amortization to operating income, you get EBITDA.Operating Income + Depreciation + Amortization = EBITDARecommended: How to Calculate Cash Flow (Formula & Examples)
What Is Revenue?
Revenue (also referred to as sales or income) consists of all income generated by a business's core activities before expenses are taken out. It includes both paid and unpaid invoices. On an income statement, revenue is listed on the top line, which is why accountants simply refer to it as the “top line.” Revenue can come from several different places, including:
Product sales
Fees charged for services
Rent
Commissions
Interest on money loaned
Revenue is typically reported quarterly and annually. Annual business revenue is how much income a company generates during one year.While revenue is vital to a company's longevity and financial health, it doesn’t show the complete picture. Because it’s a top line item, it doesn’t take into account how much the company had to spend to make that money.
What Revenue Does
Revenue is a measurement of all sales activity and can indicate how well a business is doing in the market. Revenue is also what allows a business to pay its employees, purchase inventory, pay suppliers, invest in research and development, sustain itself, and grow.Revenue can also be used as a measure of how sales are increasing or decreasing over time. If revenue is increasing from one quarter or year to the next, then the company is seeing success with its initiatives. Declining revenues year after year means that a company is shrinking or faltering. All businesses aim to increase their revenue and lower their expenses in order to maximize profit.Recommended: What Is Unearned Revenue?
How Revenue Is Calculated
Revenue is the sum of income from the sale of goods and services. Revenue from one-time events and investment income are listed separately. The formula for total revenue is:Price x Quantity Sold = Total RevenueRevenue does not take any expenses into account.
Comparing EBITDA vs Revenue
EBITDA and revenue are related financial metrics, but have some distinct differences, as well.
Similarities Between EBITDA vs Revenue
Both EBITDA and revenue are measures of a company’s financial performance and can be important predictors of a business’s future prospects. The more revenue a company generates, for instance, the more money it has to work with to pay down expenses and generate a profit. A strong EBITDA number, on the other hand, indicates that a company will be able to pay its bills and maintain or increase net income. It also indicates that a company is being run well.Investors will often look at both revenue and EBITDA to gauge the health of a business.
Differences Between EBITDA vs Revenue
The main difference between EBITDA and revenue is that revenue measures sales activity, while EBITDA measures how profitable the business is. Revenue is calculated by adding up income from all business operations, whereas EBITDA takes that revenue and then subtracts expenses in order to measure profit. Another key difference is that the Financial Accounting Standards Board (FASB), which establishes the rules and standards of Generally Accepted Accounting Principles (GAAP), requires revenue to be reported on the income statement, but not EBITDA.
Pros and Cons of EBITDA
Pros of EBITDA
Cons of EBITDA
Shows how well ongoing operations create cash flow
Doesn’t account for all expenses
A better measure of a company’s operational efficiency than net profit
Aspects of debt are overlooked
Allows you to compare operational performances across companies with different capital structures
Can be used to mislead investors about a company’s earnings
Where EBITDA Shines
Many analysts, business owners, and investors prefer EBITDA over other business metrics because it specifically measures the operational profitability of a firm. When calculating EBITDA, the only costs subtracted from revenue are ones that are directly linked to the company’s operations (such as rent, salaries, marketing, and research). Capital structure decisions, which are reflected in depreciation, amortization, and debt expenses, aren’t included. As a result, it gives analysts a way to more accurately compare performance between companies with different capital structures.
Limitations of EBITDA
However, EBITDA doesn’t reflect a business's actual net earnings (gross business income minus all business expenses). Indeed, some companies can report a seemingly strong EBITDA while stating negative profits at the bottom line.EBITDA can sometimes be misleading because costs associated with debt aren’t included. This means that any unhealthy debt decisions made by the company will be overlooked if you only look at EBITDA.EBITDA also excludes depreciation and amortization expenses. However, machines, tools, and other assets lose their value over time, and copyrights and patents expire. EBITDA fails to account for these costs.
The Takeaway
Both revenue and EBITDA are used to analyze and evaluate how well a company is performing. Revenue is the key top line on a financial statement, showing income generated by the company’s sales activities before expenses are deducted. EBITDA starts at the bottom of the income statement with net income, then adds back expenses (like interest on debt) that aren’t directly related to a company’s operations.EBITDA can be helpful for seeing how a business performs from year to year, but it does not reflect a company’s real income. That's why if you’re exploring business loans or looking to attract an investor, EBITDA will likely be one of several metrics used to gauge the health of your business.If you are interested in a small business loan, consider Lantern by SoFi. With just a single application, you can receive an offer from one of our top small business lenders, all with no obligation to you.
3 Small Business Loan Tips
Online lenders generally offer fast application reviews and quick access to cash. Conveniently, you can compare small business loans by filling out one application on Lantern by SoFi.
If you need to borrow money to cover seasonal cash flow fluctuations, a business line of credit, rather than a term loan, provides the flexibility you likely need.
SBA loans are guaranteed by the U.S. Small Business Administration and typically offer favorable terms. They can also have more complicated applications and requirements than non-SBA business loans.
Frequently Asked Questions
Are EBITDA and revenue the same?
Can EBITDA be higher than revenue?
What is considered a good EBITDA-to-revenue ratio?
Why is EBITDA better than net income?
Is EBITDA a profit or loss?
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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.
