EBIT vs. EBITDA: What’s the difference?
Earnings before interest and taxes (or EBIT) and EBITDA (earnings before interest, taxes, depreciation, and amortization) may both provide insights into a company’s profitability.
Each measurement may generally be calculated using one of two formulas.
Each calculation may provide helpful insights about valuation during mergers and acquisitions, and calculating EBITDA could also offer a way to compare profitability across different companies.
Understanding EBIT
The definition of EBIT
Earnings before interest and taxes, known as EBIT, can be a way to measure a business’s profitability. It generally shows operational profits by excluding the company’s expenses due to interest and taxes.
The EBIT formula
Typically, there are two options available to calculate EBIT:
- Option 1: Revenue - (COGS + operating expenses) = EBIT
- Option 2: Net income + interest expense + taxes = EBIT
What EBIT tells investors
EBIT may allow investors to understand how profitable a business is in relation to its primary operations.
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Understanding EBITDA
The definition of EBITDA
Earnings before interest, taxes, depreciation, and amortization, or EBITDA, can be a way to measure a business’s financial standing and its profitability without including expenses from interest, taxes, depreciation, and amortization.
The EBITDA formula
Two formula options may be used to calculate EBITDA:
- Option 1: Net income + interest + taxes + depreciation + amortization = EBITDA
- Option 2: Operating income + depreciation + amortization = EBITDA
Why EBITDA is common in valuation
EBITDA may be used in business valuations to gain insight into whether a business is profitable. Calculating EBITDA may also help a potential investor compare the financial health of various companies, perhaps for the purpose of acquiring or investing in a company. In addition, some lenders may use EBITDA to evaluate a business’s creditworthiness.
EBIT vs. EBITDA: Key Comparison
Both EBIT and EBITDA may help determine whether a business is profitable. However, EBITDA often excludes depreciation and amortization while EBIT typically does not. Because of this, EBITDA may act as a cash flow proxy, allowing additional insight into a company’s cash flow and core operations.
EBITDA may be most useful for companies that generally own high-cost assets, such as businesses that own industrial plants or companies that purchase expensive equipment. EBIT, on the other hand, could be most useful for companies that may not own high-cost assets. Calculating EBIT may create a more modest estimate of how profitable a company may be while calculating EBITDA may offer a less conservative view of a company’s profitability.
Why investors use both metrics
Both EBIT and EBITDA may offer slightly different insights into a company’s profitability. Generally speaking, EBIT may offer a more accurate look at operating profits while EBITDA may stand in as a proxy for cash flow. Investors may use both metrics if they are considering acquiring or merging with a business.
Common pitfalls to avoid
Confusing EBITDA with cash flow
The EBITDA formula may often be considered as a type of proxy for cash flow, but the two are not typically the same thing. EBITDA may not offer full insight into a company’s working capital. Viewing a company’s cash flow generally allows a potential investor to see any working capital changes within a business. Calculating a company’s EBITDA and also obtaining a broader picture of its cash flow may offer a more complete insight into a company’s financial standing.
Ignoring capital expenditures (capex)
Both EBIT and EBITDA calculations generally don’t take into account a company’s capital expenditures (also referred to as capex). If an investor doesn’t also look into a company’s capex, they may not be able to obtain a robust picture of the business’s potential expenses.
Bottom line
Calculating EBIT and EBITDA may offer useful insights into a company’s finances and profitability. These calculations can be helpful in certain situations, such as a potential merger or acquisition.
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Frequently asked questions
Calculating both EBIT and EBITDA may help provide a broader view of a company’s finances and profitability.
EBIT may be similar to operating income, but they are not necessarily the same. The main difference usually lies in how non-operating income or one-time expenses are treated.
Lenders may prefer to use EBITDA since it typically allows insight into a company’s core operations and its potential to generate revenue. EBITDA may also offer lenders a way to compare a company’s profitability to others.
The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.
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