Calculating Profitability: EBIT vs. EBITDA (2024)

Earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciationand amortization (EBITDA) are two commonly used measures of business profitability. As theirnames suggest, there are similarities between the two metrics. EBIT is net income beforeinterest and taxes are deducted; EBITDA is similar, but also excludes depreciation andamortization — in practice, EBIT measures a company’s ability to generate profitfromits operations. Some investors are wary of using EBITDA to assess profitability because theybelieve it can give a misleading picture of a company’s financial health.

Key Takeaways

• EBIT and EBITDA are both measures of a business’s profitability.
• EBIT is net income before interest and taxes are deducted.
• EBITDA additionally excludes depreciation and amortization.
• EBIT is often used as a measure of operating profit; in some cases, it’s equal tothe GAAP metric operating income.
• Companies in asset intensive industries often prefer EBITDA over EBIT.
• Neither EBIT nor EBITDA are GAAP metrics; some investors are particularly wary ofEBITDA, because they believe it can give a misleading picture of a company’sfinancial health.

EBIT vs EBITDA: Key Differences

Both EBIT and EBITDA are measures of the profitability of a company’s core businessoperations. The key difference between EBIT and EBITDA is that EBIT deducts the cost ofdepreciation and amortization from net profit, whereas EBITDA does not. Depreciation andamortization are non-cash expenses related to the company’s assets. EBIT thereforeincludes some non-cash expenses, whereas EBITDA includes only cash expenses.

Neither EBIT nor EBITDA are approved metrics under U.S. Generally Accepted AccountingPrinciples (GAAP), a set of rules maintained by the Financial Accounting Standards Board(FASB). For this reason, public companies and others that must comply with GAAP cannot useEBIT or EBITDA to fulfill statutory reporting requirements, although they may choose toreport them in addition to the GAAP-approved metrics.

What is EBIT?

Earnings before interest and taxes (EBIT) is a common measure of a company’s operatingprofitability. As its name suggests, EBIT is net income excluding the effect of debtinterest and taxes. Both of these costs are real cash expenses, but they’re notdirectly generated by the company’s core business operations. By stripping outinterest and taxes, EBIT reveals the underlying profitability of the business.

The information used to calculate EBIT is found on your income statement. Also known as aprofit and loss statement, it’s a way to see your company’s expenses andrevenues over a given time — usually three months. Tracking that information can bedonewith spreadsheets, but that can be time consuming, inaccurate and increasingly difficult asyour business grows and matures. Even smallbusinesses can benefit from accounting software to help track expenses. Thebest-in-class accounting solutions can also integrate seamlessly with other enterpriseresource planning (ERP) solutions, such as payroll, human resources management and inventorymanagement.

How to Calculate EBIT

There are two ways to calculate EBIT. The first method starts with netincome and adds back interest expenses and taxes paid or provisioned:

EBIT = Net income + interestexpenses + taxes

EBIT = Sales revenue - COGS -operating expenses

EBIT calculated using the second method is always equal to operating income as defined under GAAP, butEBIT calculated using the first method differs from operating income if net income includesnon-operating income and/or expenses.

EBIT Analysis

EBIT is a measure of operating profit. This is true for both calculation methods. Byeliminating the effect of interest and taxes, it shows the business’s underlyingprofitability regardless of the company’s capital structure or the tax jurisdictionwhere it operates. Business owners and managers can use EBIT to get a picture of theirbusiness’ competitiveness and its attractiveness to investors. Investors and analystscan use EBIT to compare companies in the same industrial sector that have different capitalstructures or operate in different tax jurisdictions.

However, because EBIT excludes the cost of servicing debt, it can give a misleadingimpression of a company’s financial resilience. A highly leveraged company couldreport the same EBIT as a company with very little debt, but the highly leveraged companymight be more likely to fail if it suffered a sudden drop in sales.

EBIT is just one measure of your company’s financial health. But it, and otherfinancial reports and metrics, rely on accurate and up-to-date data. Business accountingsoftware helps you accurately report EBIT and other measures.

What is EBITDA?

Earnings before interest, taxes, depreciation and amortization is a measure of businessprofitability that excludes the effect of capitalexpenditure as well as capital structure and tax jurisdiction.

As its name suggests, EBITDA differs from EBIT by excluding depreciation and amortization.Depreciation and amortization are accounting techniques that spread the cost of an assetover several years, resulting in a recurring expense that is deducted from thecompany’s revenue each year. Depreciation is applied to fixed, tangible assets such asmachinery, whereas amortization is used for intangibles such as patents. Depreciation andamortization are not cash expenses, and don’t affect a company’s liquidity. So,excluding depreciation and amortization can give business managers a comparison of theircompany’s performance with other companies in the same industry.

However, since it does not include movements in working capital, it is not equivalent tooperating cash flow as defined under GAAP. Some companies report an adjusted EBITDA measurethat also excludes a variety of one-off and exceptional items.

How to Calculate EBITDA

There are two widely used methods of calculating EBITDA. The first method starts with netincome and adds back interest, taxes, depreciation and amortization:

EBITDA = Net income + interestexpense + taxes + depreciation + amortization

If you’re calculating EBITDA from a company’s financialstatements, you’ll find net income, interest expense and taxes on the incomestatement. Depreciation and amortization are sometimes listed separately as items onthe income statement or on the cash flow statement. Alternatively, they may be bundled intooperatingexpenses, in which case you can usually find them in a note accompanying theaccounts.

The second method starts with EBIT, calculated using one of the two methods describedearlier, and adds back depreciation and amortization. The formula is:

EBITDA = EBIT +depreciation +amortization

EBITDA Analysis

EBITDA strips out the cost of the company’s asset base as well as its financing costsand tax liability. By removing all non-operating expenses, EBITDA gives what some might seeas a purer view of your business’s underlying profitability and can provide anindication of its ability to generate free cash from its operations.

EBITDA is especially useful as a profitability measure in asset-intensive industries wherecompanies are often highly leveraged. For these companies, the annualdepreciation/amortization and interest expenses associated with those assets cansignificantly reduce bottom-line profits.

However, because EBITDA excludes these costs, it can give a misleading impression of acompany’s financial health. Interest and taxes are real business expenses that draincash from a company. And although depreciation and amortization are accounting techniquesrather than real cash outlays, many assets really do lose their value over time andeventually will have to be replaced. Thus, EBITDA may give the impression that acompany’s expenses are lower than they really are, and therefore that it is moreprofitable than it really is.

Why Calculate Each One?

EBIT and EBITDA serve slightly different purposes. EBIT is a measure of operating income,whereas. Depending on the company’s characteristics, one or the other may be moreuseful. Often, using both measures helps to give a better picture of the company’sability to generate income from its operations.

Example of EBIT vs EBITDA

Consider a company whose income and cash flowstatements look like this:

The high interest expenses and depreciation/amortization costs reflectthe fact that the company has a high level of debt and a significant base of assets that aredepreciating over time.

Calculating EBIT from net income:

Calculating EBIT from revenue:

The cash flow statement gives us the depreciation and amortization thataren’t shown separately on the income statement. So, calculating EBITDA:

For this company, EBITDA is higher than EBIT, so the company mightprefer to highlight EBITDA as a performance metric.

Why Is EBITDA Preferred to EBIT?

EBITDA is often preferred over EBIT by companies that have invested heavily in tangible orintangible assets, and therefore have high annual depreciation or amortization costs. Thosecosts reduce EBIT as well as net income. These companies may prefer to use EBITDA, which isgenerally higher because it excludes these costs, as a better indicator of the underlyingprofitability of business operations.

EBITDA is also a popularmetric for leveraged buyouts, in which an investor finances the acquisition of acompany with debt. The investor then loads the debt onto the acquired company’sbalance sheet and withdraws cash from the company to make interest payments on the debt.Because it can be used to estimate cash flow, EBITDA can provide some idea of whether thetarget company is capable of generating the cash needed to pay the interest on the debt.

What Does a Low EBIT but High EBITDA Indicate?

If your company has low EBIT but high EBITDA, it has high depreciation and/or amortizationexpenses. This means it likely has a large number of fixed assets and is gradually writingdown the value of those assets over time.

Suppose a fast-growing company with substantial cash reserves is experiencing strong demandfor its products. To meet demand, it buys additional production machinery. Because thecompany can pay for the machinery from its cash reserves, the purchase increases thecompany’s tangible asset base but doesn’t add any debt. IRS rules allow thecompany to depreciate the assets over five years. Over those five years, therefore, thecompany will have increased depreciation costs but low interest charges. EBIT excludes theinterest charges but not depreciation, whereas EBITDA eliminates both. As a result, EBITDAwill be higher than EBITDA.

EBITDA would also be higher than EBIT if the company acquired an intangible asset such as apatent and amortized the cost. However, intangible assets can’t always be amortized.Suppose that a public company acquires several subsidiaries for more than the market valueof the subsidiaries’ assets. The additional value appears on the parentcompany’s balance sheet as an intangible asset called goodwill, which represents thevalue of anticipated future cash flows from the subsidiaries. The FASB says that publiclytraded companies should not amortize goodwill, though private companies and not-for-profitsmay choose to do so.

The value of goodwill may be written down at some point if, for some reason, the acquiredcompany is determined to be less valuable than originally expected — this is calledimpairment. But generally speaking, the company now has a larger asset base, meaning thatthe relationship between EBIT and EBITDA doesn’t change significantly.

Which Do You Need and Why?

If a company has high interest costs, it may prefer to highlight the company’soperating profitability rather than its net income, and therefore it will choose EBIT as akey performance indicator.

However, if the reason for the high interest costs is that the company has financedlarge-scale capital investment with debt, then it may prefer to use EBITDA, sincedepreciation and amortization charges are likely to depress EBIT.

Many managers may prefer to highlight EBITDA rather than EBIT if there’s a bigdifference between them, which might be the case if the company has paid for assets in cash.However, some investors are wary of EBITDA. Warren Buffet, for example, has said it’stoo often used to “dress up” financial statements.

Using Accounting Software to Measure EBIT and EBITDA

EBIT and EBITDA are both widely used to measure and compare the profitability of businesses.They can be useful for demonstrating a company’s ability to generate profit from itscore operations after stripping away the effect of interest payments on debt, taxes and— inthe case of EBITDA — capital expenditure. However, neither EBIT nor EBITDA areGAAP-approvedmetrics, so companies that must comply with GAAP should use them in conjunction withapproved metrics. Some investors are extremely wary of EBITDA because they think it can givean inaccurate view of a company’s financial health.

Cloud accountingsoftware can help you track and report these and other financial metrics. Withreal-time access to all of your financial data, you can stay on top of what’shappening in your business whether you're in the office or working remotely. That way, youalways have the most comprehensive and accurate view possible so you can make the beststrategic decisions for your business.