Several metrics are used to determine a company's profitability. EBIT and EBITDA are two of the most widely used tools by analysts and investors. EBIT stands for earnings before interest and taxes, whereas EBITDA stands for earnings before interest, taxes, depreciation, and amortisation. While these share a few similarities, they are also different in terms of computation and lead to varying outcomes.
In this article, we will focus on the main differences between EBIT and EBITDA.
EBIT vs. EBITDA - What is the difference
EBIT and EBITDA are metrics used to measure the profit levels of a company’s primary operations. The main difference between the two is that EBIT eliminates the depreciation cost and amortisation from net profit, and EBITDA does not. Both depreciation and amortisation are non-cash expenditures of the business’s assets. Simply put, EBIT factors in some non-cash expenditures, whereas EBITDA only factors in cash expenditures.
Please note that none of these measures are metrics approved by GAAP.
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Understanding EBIT
Earnings before interest and taxes (EBIT) is the net income that eliminates the impact of interest and taxes. These are cash expenses, but they are indirectly produced by an organisation’s core operations. By excluding interest and taxes, EBIT tells you the underlying gains earned by the company.
The data used to compute EBIT can be retrieved from a company’s income statement. Also called a profit and loss statement, EBIT enables you to see a business’s revenues and expenses over a period—which is usually listed in a quarterly timeline.
How is EBIT computed
To compute the EBIT of a company, two methods can be employed. The first method involves adding net income with interest expenses and tax paid. Here is the formula.
EBIT = Net income + Interest Expenses + Taxes
In the second method, a company’s revenue is subtracted from the cost of goods sold (COGS) and operating expenses. Here is the formula.
EBIT = Revenue – COGS – Operating Expenses
EBIT analysis
Both computation methods listed under EBIT are a measure of operating profit. By excluding the weight of interest and taxes, it demonstrates a company’s underlying profit levels no matter what the company’s capital structure or tax jurisdiction looks like. Entrepreneurs can use the EBIT figures to get a lucid picture of a company’s condition in its competitive landscape and its appeal in the investing circles. Likewise, financial analysts and investors employ EBIT to compare companies belonging to the same sector with varying capital frameworks and tax jurisdictions.
However, since EBIT does not factor in the expense of servicing debt, it could give an ambiguous image of an organisation's financial capabilities. A business that is highly leveraged could report the same EBIT as an organisation with low debt, but the highly leveraged business would possibly succumb if it has to deal with sudden declines in sales revenue.
Please note that EBIT is just one of the fiscal tools that helps you understand an organisation’s financial well-being. Ensure you are taking into account additional and supporting key metrics to understand the potential of the business.
Understanding EBITDA
Earnings before interest, taxes, depreciation and amortisation, or EBITDA, measures a company’s profitability like EBIT but eliminates the capital expenses alongside capital structure and tax jurisdiction.
Unlike EBIT, EBITDA excludes depreciation and amortisation. This is the key difference between EBIT and EBITDA. These are accounting methods that distribute an asset over the years, causing it to be a periodic cost that is deducted from the organisation’s revenue every year. Depreciation is used for fixed, tangible assets like machinery. On the other hand, amortisation is applied to intangibles like patents. Since these are not cash expenses, they do not impact the liquidity of an organisation. Therefore, eliminating depreciation and amortisation can help business managers gauge their business’s performance by enabling them to compare it with other companies in the same sector.
However, because it does not factor in fluctuations in working capital, it is not equal to operating cash flow. Certain organisations report an adjusted EBITDA that also eliminates several one-off and unique items.
How is EBITDA computed
There are two popular methods to compute EBITDA. The first method involves net income, in addition to interest expense, taxes, depreciation and amortisation. Here is the formula.
EBITDA = Net income + Interest + Taxes + Depreciation + Amortisation
If you are computing the EBITDA figure from an organisation's fiscal statements, you will discover net income, interest, and taxes on it. On occasions, depreciation and amortisation are separately mentioned items on the cash flow or income statement. Conversely, they may be added to operating expenses. In this case, you will typically find them on the note that goes with the accounts.
The second method involves EBIT and adds depreciation and amortisation. Here is the formula.
EBITDA = EBIT + Depreciation + Amortisation
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EBITDA analysis
EBITDA removes the expense of an organisation’s asset base along with its financial expenses and tax liability. By excluding every non-operating expense, the EBITDA measure gives a clearer picture of a company’s underlying profit levels and insights into its potential to produce free cash from its operations.
It is particularly productive as a profitability metric in asset-intensive sectors where organisations are typically highly leveraged. For such businesses, the yearly depreciation or amortisation and interest associated with assets can substantially reduce final profits.
Since EBITDA eliminates these expenses, it could provide an obscure impression of an organisation’s fiscal health. Interest and taxes are relevant business costs that can bleed the company’s cash reservoir. Though depreciation and amortisation are accounting manoeuvers than actual cash expenditures, many assets will lose their value over a period and will have to be replaced eventually. Therefore, EBITDA could give an impression that a business’s costs are lower, automatically implying it is making more gains than it really is.
Primary differences between EBIT and EBITDA
| EBIT | EBITDA |
| Eliminates interest and taxes | Eliminates interest, taxes, depreciation and amortisation |
| Includes non-cash outlays like depreciation and amortisation | Does not include non-cash outlays |
| Is widely reported, typically by highly leveraged organisations with good operating earnings | Usually preferred as a profitability measure for organisations that have substantial investments in fixed assets which are sponsored by debt |
| Could give an obscure impression of an organisation's ability to deal with declines in revenue | Could give an ambiguous impression of an organisation’s overall financial well-being |
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Why is EBITDA preferred to EBIT
Companies prefer EBITDA to EBIT if they have made heavy investments in tangible and intangible assets, which results in significant yearly depreciation or amortisation expenses. Likewise, businesses may choose to use EBITDA, which is generally higher because it excludes such costs and serves as an improved indicator of the underlying profit levels of the company’s operations.
EBITDA is also widely preferred for leveraged buyouts, where investors finance acquisitions of an organisation with debt. Investors then put the debt on the acquired business’s balance sheet and withdraw cash from the company to pay the interest on the debt. Since it can be employed to predict cash flow, EBITDA offers an idea of whether the targeted organisation is resilient enough to generate the cash required to make interest payments on the debt.
What does a high EBITDA but a low EBIT mean
If the company has high EBITDA but low EBIT, it indicates it has greater depreciation and amortisation costs. So, it is likely to possess many fixed assets and is slowly writing down the assets’ value over a period.
Closing thoughts
Earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation, and amortisation (EBITDA) are similar types of profitability metrics. However, EBITDA also adds back depreciation and amortisation—a main difference between the two metrics. Usually, many investors and analysts pick EBITDA to compare companies with a substantial amount of fixed assets.
