Comparing Operating Income and EBITDA: Similarities and Differences

Lauren Ward

Updated June 28, 2022

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Operating income and EBITDA are both ways to measure a company’s financial performance, but they have some key differences. Operating income is how much a company makes from its core business activities after operating expenses have been taken into account. It’s compliant with the generally accepted accounting principles (GAAP), the accounting standards public companies in the U.S. must follow.EBITDA, on the other hand, is how much a company makes before the effects of interest, taxes, depreciation, and amortization. It is not GAAP-compliant, but is a good formula for comparing the financial health of two different companies in the same industry. While many people wonder whether EBITDA is the same as operating income, the short answer is, no. Operating income adds back some of the expenses that EBITDA strips out. However, these two metrics are related. Here’s what you need to know about operating income vs. EBITDA, how they are similar and different, and why they are both important.Recommended: What Is GAAP & How Does It Work?

What Is Operating Income?

Operating income is the amount of profit a company earns from its operations, after deducting operating expenses such as wages, depreciation, and cost of goods sold (COGS). To calculate operating income, any expenses that revolve around the production of goods, or the execution of any services, are subtracted from operating revenue. Of the three financial statements a business must produce (balance sheet, income statement, and cash flow statement), operating income appears on the income statement. Analyzing operating income is helpful to investors because it doesn't include taxes and other one-off items that might skew profits. Lenders may also look at operating income (from current and previous income statements) when a business owner applies for a small business loan. A company that shows an increasing amount of operating income is viewed as doing a good job of generating more revenue while controlling expenses, production costs, and overhead.

How Operating Income Is Calculated

This is the basic formula for calculating operating income:Operating Income = Gross Income - Operating ExpensesOperating expenses are expenses a business incurs through its normal business operations, including: selling, general, and administrative expenses; depreciation and amortization: and other operating expenses.

What does operating income not include?

Operating income does not take into account any money received or lost through non-core or non-operating business activities. This means the following data is not taken into account when calculating operating income:

Real estate sales
Investment income
One-time transactions
Stock market gains
Dividend income
Interest income
Interest on debt
Taxes
Lawsuit settlements

On its own, operating income is not a complete picture of a company’s financial health, but it is a very important facet. While a company may make a sizable amount of money from non-operating activities, most companies generate a majority of their revenue from their operating revenue. Because of this, operating income illustrates a majority of their cash flow. Recommended: Net Operating Income vs EBITDA

What Is EBITDA?

EBITDA is earnings before taxes, interest, depreciation, and amortization. It’s not an official GAAP 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 all types of business loans. The reason EBITDA excludes it 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: Income tax varies from one location to another. 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 only logical to remove their tax burdens.Depreciation & Amortization:Depreciation and amortization involve spreading out the cost of an asset over the course of its useful life. For many companies, depreciation and amortization are very real costs that cannot be avoided. However, EBITDA adds these non-cash expenses back to net income because they depend on the historical investments the company has made, not on its current operating performance. Plus, there are not always hard and fast rules about how to calculate depreciation and amortization, which means methods can vary from company to company.

EBITDA vs Cash Flow

Is EBITDA the same as operating cash flow? Not exactly. When comparing cash flow vs EBITDA, keep in mind that both track the cash flow generated by a business's operations and ignore cash flow from investing or financing activities. However, EBITDA doesn't factor in interest or taxes, whereas operating cash flow does, since they are cash expenses. Recommended: EBITDA vs gross profit

How EBITDA Is Calculated

EBITDA is calculated by adding certain expenses back to net income. To calculate it, the following data is required:

Net income
Interest expenses
Taxes
Depreciation costs
Amortization costs

Comparing EBITDA vs Operating Income

EBITDA and operating income have both similarities and differences. Here’s a look at how they stack up.

Similarities

Both are a measure of a company’s profitability
Neither consider the costs of interest and taxes
Neither is indicative of a company’s overall financial health

Differences

EBITDA adds depreciation and amortization back to net income: operating income subtracts them from operating revenue
EBITDA includes gains or losses from non-operating income; operating income does not
Operating income suggests how much profit can be gained from operating revenue if operating expenses are lowered; EBITDA suggests a company’s income potential if certain variables like interest or taxes can be mitigated.

How Operating Income and EBITDA Are Related

Both operating income and EBITDA measure a company’s profitability. EBITDA strips out some of the costs of doing business in order to more clearly show the profitability of a company’s core operations. Operating income adds some of those costs back in to show the company's actual net profit.

EBITDA Formula

There are two formulas for EBITDA.Option 1: EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization Option 2:EBITDA = Operating income + Interest + Taxes + Depreciation + Amortization

How Operating Income Fits Into the Formula

Operating income is used in the second formula to calculate EBITDA (Operating income + Interest + Taxes + Depreciation + Amortization). Starting with operating income rather than net income may yield a different EBITDA result, depending on what’s included in operating income. In some cases, net income includes line items that might not be included in operating income, such as non-operating income or one-time expenses (such as restructuring expenses).

Operating Income vs EBITDA Example

To understand how much EBITDA can change a company’s numbers, let’s take a look at Tesla. The following data was pulled from Tesla’s 2021 annual income statement:(Note: All data listed is in U.S. millions.) Notice the difference between Tesla’s net income and EBITDA numbers. While it reported a net income of $5,519, its EBITDA was $9,434. That’s a difference of $3,915. However, Tesla is very much a tangible asset company, which means it has a lot of recurring costs revolving around manufacturing. Therefore, depreciation and amortization are very real expenses that it can’t avoid, so analysts and investors aren’t likely to take EBITDA numbers seriously.

Pros and Cons of Using Operating Income

The Takeaway

EBITDA stands for earnings before interest, taxes, depreciation, and amortization. It is useful when comparing the financial performance of two different companies because it removes the effects of any accounting or financing decisions that owner’s have discretion over.Operating income is how much a company makes from its core business operations after any related expenses are taken into account. It adds back some (but not all) of the numbers that are excluded from EBITDA.Looking at both operating income and EBITDA provides a more complete picture of a company’s financial performance and potential than either one alone.When it comes to getting financing, lenders will likely look at both of these metrics. EBITDA tells them whether your business is generating more cash flow than the amount of the loan payments. Growth in operating income indicates that your company will continue to be profitable.

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Photo credit: iStock/vgajicThe tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.LCSB0322001

Frequently Asked Questions

How do you calculate operating income from EBITDA?

Is operating income the same as EBITDA or the same as EBIT?

Is operating income or EBITDA better?

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.

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