EBIT vs EBITDA | Top Differences | Examples | Calculation

What is Operating Profit? Let us have a look at the Income Statement of Colgate above. Is it EBIT (Earnings Before Interest and Taxes) or EBITDA (Earnings Before Interest Taxes Depreciation & Amortization)?

The operating profit is EBIT. EBIT defines any company’s profit, including all expenditures just leaving income tax and interest expenditures. However, the EBITDA measure is good for analyzing and comparing profitability between firms and businesses as it removes the impacts of accounting and financing decisions.

In this article on EBIT vs. EBITDA, we look at its differences & usage in depth.

In finance and accounting, earnings before interest and taxes (EBIT) are defined as any company’s profit, including all expenditures just leaving income tax and interest expenditures. The formula defines it:

EBIT Formula = operating revenue – operating expenses or OPEX

If the company doesn’t have non-operating income for calculation purposes, then operating income may be used similarly to operating profit and EBIT.

Earnings before interest, taxes, depreciation, amortization, or EBITDA, an accounting term calculated through the firm’s net earnings, before interest, taxes, expenses, amortization, and depreciation deducted, is a substitute for a firm’s existing operating profitability. The formula defines it:

EBITDA = EBIT or operating profit + depreciation expenditure + amortization expenditure

Or, EBITDA = Total profit + Amortization + Depreciation + Taxes + Interest

Adding the company’s overall expenditures due to amortization and depreciation back to its EBIT.

EBITDA is net income added to amortization, depreciation, taxes, and interest. EBITDA measure is good for analyzing and comparing profitability between firms and businesses as it removes the impacts of accounting and financing decisions.

Verizon provides Consolidated EBITDA as a non-GAAP measure. Verizon management believes that these measures are useful for investors in evaluating the profitability and operating performance of the company.

source: Verizon Annual Report

As seen below – EBITDA = EBIT (Operating Income) + Depreciation and Amortization.

source: Verizon Annual Report

Also, note that EBITDA is most often used for evaluating valuation ratios (EV/EBITDA) against calculating revenue and enterprise value.

EBIT vs EBITDA - Example 1

Suppose there’s a construction company having $70,000 revenue last year. But, the firm’s operating expenditures were recorded at $40,000. Therefore, EBIT = $70,000 – $40,000 = $30,000.

The expenditures include administrative, general, selling, cost of goods sold (COGS), utilities & rent, salaries, amortization, and depreciation.

• Add any depreciation expenses.

Now, extending the same example for calculating EBITDA with key assumptions, including working lifetime expectation for the asset of 10 years. For example, suppose the machinery purchased by the company some time back had a consolidated value of $30,000 with a working life of, say, ten years. In such a case, upon assuming straight-line or linear depreciation, the machinery would together depreciate by $30,000/10 = $3,000 per year.

• Add any amortization expenses.

Amortization is linked to depreciation; however, it isn’t the same technique. Amortization denotes the expenditures witnessed from the strategic acquisition of key intangible assets at any time over their complete life, while depreciation is used for tangible assets. Typically, amortization expenditures are recorded in line with depreciation expenditures on any company’s P&L or cash flow statements. Sum up any listed amortization expenditures for obtaining and recording one unique value.

• For instance, assume that some time back, a company spent $2,000 to obtain the rights for some famous Sufi songs to be used in the commercials. Suppose this money purchased the song rights for, say, five years.
• Thus, Amortization expense = $2,000/5 years = $4, 00/year

Now, calculating EBITDA using the formula,

EBITDA = EBIT + amortization + depreciation

Adding back the expenditures due to amortization and depreciation to the firm’s EBIT. EBITDA is the calculation of net earnings before amortization, depreciation, taxes, and interest. As amortization and depreciation were previously subtracted for EBIT calculation, one must add them again to find EBITDA.

• In the above example about the construction company, let’s believe that the amortization and depreciation expenses identified earlier are just the costs incurred by the company (actually, one might find it crucial to add numerous depreciation or/and amortization expenditures to arrive at the net value).
• For this case, let’s evaluate EBITDA through the formula, EBITDA = amortization + depreciation + EBIT. $400 + $3000 + $30,000 = $33,400. Hence, the company’s EBITDA was calculated to be $33,400.

EBIT and EBITDA - Example 2

Suppose a retail firm delivers $100 million of revenue and witnesses $40 million of product expense and $20 million of operating expenditures. Amortization and depreciation expenditure was recorded at $10 million, delivering a net profit from operations of $30 million. Further, the interest expenditure is $5 million, making $25 million of earnings before taxes. Assuming a tax rate of 20%, net income becomes $20 million, posts $5 million of taxes that are deducted from the company’s pretax income. Employing the EBITDA formula, let’s sum operating profit with depreciation and amortization expenditure to arrive at the EBITDA equals $40 million ($30 million added to $10 million).

EBIT and EBITDA - Example 3

In the above example, company B has illustrated a better EBITDA measure compared to company A despite having comparatively smaller top line growth.

EBITDA is defined by cash flow from operations that minimizes the impact of tax policies, financing, and accounting on stated profits.

Below is the snapshot of the Income Statement of Colgate. As we saw earlier, the Operating Profit reported is EBIT (Earnings Before Interest and Taxes). However, if you look at the Income Statement closely, you will not find the Depreciation & Amortization line item.

A further look at Colgate’s accounting disclosures reveals that depreciation attributable to manufacturing operations is included in the Cost of Sales (before the Gross Profit). And the remaining depreciation is included in the SG&A expense or Selling General and Admin expense.

The best and the easiest way to find Depreciation and Amortization is to look at the cash flow statement. Cash Flow from Operations includes the depreciation and amortization figures.

EBITDA (2015) = EBIT (2015) + Depreciation & Amortization (2016)

EBITDA 2015 = 2,789 + 449 = $3,328 million

Likewise, EBITDA (2014) = 3,557 + 442 = $3,999 million

Let us look at a typical Services Company EBIT/EBITDA and Capital Intensive Firm (manufacturing firm) EBIT/EBITDA

Services companies do not have a large asset base. Therefore, their business model is dependent on Human Capital (employees). Due to this, depreciation and amortization in Services Companies are generally non-meaningful. However, Manufacturing Companies (or Capital Intensive companies) invest heavily in their setup and are dependent on investments in assets to manufacture goods. Therefore, its depreciation and amortization are relatively higher with a higher asset base.

Consider the example below -

Both the companies have equal EBITDA while the company’s EBIT is $20 billion, but the company’s B EBIT is a mere $0 billion.

EBIT vs. EBITDA of Infosys - Service Companies

The difference between EBIT and EBITDA margins can tell us the relative amount of depreciation and amortization in the Income Statement. For example, the graph below shows that the difference between EBIT Margin and EBITDA Margin for Infosys is approximately 1.24% (27.34% – 26.10%). This is expected from a services firm as they operate as an Asset Light model.

source: ycharts

EBIT vs EBITDA of Exxon (Capital Intensive Firm)

Now let us compare the above graph with that of Exxon. Exxon is an Oil & Gas company (highly capital intensive firm). As expected, we note that the difference between EBIT Margin and EBITDA margin is very high – approximately 8.42% (13.00% – 4.58%). This is because the heavy Property Plant and Equipment investment leads to high depreciation and amortization figures.

source: ycharts

EBITDA Data must be used responsibly

• Never use EBITDA as a key technique for determining the company’s financial strength. EBITDA is expected to have some utility in a financial study. For example, it’s a simpler technique for identifying the amount of money that the company needs to reimburse for the remaining debts over the short-term – suppose a company has $2,000 for interest payments; however, $3,000 as EBITDA, it’s observed that the firm has enough money to settle its debt. But, as EBITDA doesn’t take into account key expenditures, and since it can be easily altered, it’s foolish to just use it as the sole measurement of the company’s strength. (also, look at Interest Coverage Ratio)
• EBITDA doesn’t prove to be an accurate indicator of whether any company is making money or losing money. Any company can illustrate positive EBITDA while having negative free cash flows. Therefore, EBITDA can falsely make any company appear much better than it truly is.

A company's EBITDA shouldn't be purposefully manipulated.

• EBITDA may be altered through corrupt accounting methods. For instance, as amortization and depreciation are evaluated fairly in detail (through experience, estimates, and projections), the company’s EBITDA is likely to be altered by its amortization and depreciation plans. However, amortization and depreciation are non-cash expenditures (cash has previously been swapped for the amortizing/ depreciating assets). However, they are present for some reason. Finally, intangible assets perish, and equipment flops. After this takes place, extremely real cash expenditures take place.
• As a practical case of EBITDA management, Worldcom capitalized items that should have been expensed. Capitalization increased the depreciation, resulted in higher profit (due to reduced expenses), and reported higher EBITDA keeping the analysts happy.

Never use EBITDA multiple to misrepresent any firm.

• EBITDA is not a reliable multiple for determining any company’s financial health. It can be easily altered to post a rosy picture about any company that is enough to misguide the lenders and investors. For example, in some businesses, the limit for taking loans is determined by calculating the EBITDA percentage; therefore, by controlling the firm’s EBITDA, business holders can easily deceive lenders into offering huge loans against normal lending conditions.
• Fake practices such as these are crafted to fraud a firm’s stakeholders are corrupt and may even be unlawful.

• EBITDA is an adjusted figure that enables healthy decision-making capabilities for what must and should not be taken while performing the calculation. Further, it also signifies that firms often alter the elements involved while performing EBITDA calculations across different reporting periods.
• EBITDA was first introduced with leveraged buyouts during the 1980s, while it was employed to identify the capability of any company to successfully service the entire debt. With time, EBITDA became extremely popular among industries with exclusive assets that required writing down over longer periods. At present, EBITDA is most commonly used by several companies, particularly belonging to the tech segment, although it stays warranted.
• The most common delusion comprises EBITDA equivalent to cash earnings. However, EBITDA forms a good evaluator of profitability; however, not cash flows. EBITDA even forgets the total cash needed for funding the working capital and old equipment replacement, which may be notable. Thus, EBITDA is frequently used as an accounting trick for making any company’s earnings appear lucrative to investors. While using this technique, it is important that stockholders also emphasize other key performance metrics to ensure that the company isn’t hiding something under the EBITDA metric.

• Pretax Income Formula
• Differences of EBITDA and Operating Income
• EV to EBITDA Multiple
• Enterprise Value to Sales