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What Are EBIT and EBITDA?

Accountants discussing EBIT and EBITDA

The abbreviations EBIT and EBITDA are commonly used by financial analysts when looking at business performance. These metrics can also help small business owners and investors, so here we’ll explain what they are and how they are calculated.

Definition of EBIT

In both accounting and finance, EBIT means earnings before interest and taxes. Using this method, accountants subtract expenditures to the profits of the company. 

The only components that they exclude are income tax as well as interest expenses. Accountants and investors use a formula to calculate EBIT:

EBIT = Operating Expenses (OPEX) – Operating Revenue 

If a company doesn’t have non-operating income, then for calculation purposes, accountants may use operating income, as it’s similar to EBIT and operating profit.

Definition of EBITDA

It can be easy to confuse EBITDA and EBIT. EBITDA is simply the earnings that a company generates before deducting interest, taxes depreciation and amortisation from total income.

EBITDA is the fancy way of saying profit or earnings, so a bigger number is better.

Here’s the EBITDA formula that accountants and investors use:

EBITDA = Operating Profit (EBIT) + Amortization + Depreciation

Here’s another formula for calculating EBITDA used by accountants:

EBITDA = Interest + Total Profit + Taxes + Amortization + Depreciation

EBITDA, in other words, means net income that gets added to depreciation, amortisation, interest, and taxes. It is used to evaluate a company and its profitability.

Financial analysts use this information to compare companies, and it’s one of the best ways to analyse a firm. EBITDA measures a company’s financial performance and its earnings potential. It also removes the impacts of finance and accounting decisions.

Investors look at several factors before investing in a company. EBITDA excludes depreciation and other charges from profit. So EBITDA on the income statement plays a vital role in decision making and helps people understand the capital structure of an organisation.

This covers the profit a company is making before it pays tax and interest on its debt. As a result, investors will be in a better position to invest in a company after checking EBITDA margins.

Significant differences between
EBIT and EBITDA

EBIT EBITDA
The EBIT method is used to show the earnings of a company before interest and tax. But it is done immediately after calculating depreciation. The EBITDA method shows the earnings of a company before calculating amortisation or depreciation expenses.
EBIT is used to determine a company’s profit by considering all expenses, leaving out interest and tax expenses. EBITDA helps in determining the actual operating performance of a company without taxes depreciation and interest.
Operating results are calculated using the accumulation basis. Operating results of a company are calculated using cash flow of the firm.
EBIT = Operating Expenditures – Revenue EBITDA = Operating Expenditures (without deducting depreciation and amortisation) – Revenue

Example: calculate EBIT & EBITDA of a facility management company

Here’s an example that you can use that you may need to consider if you want to understand EBIT and EBITDA:

A facility management company has generated $900,000 in the year 2018 as revenue. The operating expenditures of this particular company were around $ 500,000 during the year. By subtracting operating expenses from income, you will get EBIT.

In the example above, EBIT = $900,000 – $500,000 = $400,000

These expenses include rent, salaries, administrative, cost of goods sold, and others. The amount that you get using the calculation above is also called operating income.

Calculating EBITDA is a little different from calculating EBIT. Here’s how we can calculate the EBITDA using the same example:

We first need to add the depreciation costs. For example, the facility management company has bought some tangible asset or equipment worth $400,000 and that equipment’s lifetime is ten years.

Then the depreciation amount that we get using the linear depreciation or straight line is $ 40,000 per year. You get this amount by dividing the total equipment cost with the number of years that the equipment is going to work.

$400,000 (equipment cost) ÷ 10 (lifetime of the equipment) = $40,000 (every year for the next ten years)

Now, we have to check and add amortisation expenses. Though amortisation and depreciation look like the same thing, they are two different things.

Companies use depreciation to calculate the amount of money that they can spread across over the lifetime of the product. Businesses spread the purchases on tangible assets across the lifetime of that product or item for taxation purpose. It helps them to save some money over a period.

Accountants in a company, however, use amortisation on intangible assets of a company.

For example, if the facility management company bought the rights of a pop song for $2,000 that they are planning to use for the next five years in promoting their products.

You get the amortisation costs by dividing the total amount of $2,000 (amount paid to get the rights) divided by the total number of years they can use it, which is 5.

The amortisation cost is $2,000/5 = $400 per year. With these numbers:

EBITDA = $40,000 (Depreciation)+ $400 (Amortisation) + $400,000 (EBIT)  = $440,400

Summary

These two key metrics help investors check an organisation’s financial performance. Businesses can use them to determine how well they are doing by checking the profits or earnings of the firm. 

For investors, these metrics can be helpful when comparing companies to invest in.

Companies can also use this information to analyse their present financial condition and find ways to improve company profits.

To learn more about ways to measure business performance, check out Financial Key Performance Indicators: How Can They Help Your Business?

Author:

All the thoughts, ideas and musings from the Moula team! Covering everything from work/life balance to general finance tips plus everything in between!

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