EBIT vs EBITDA: Which profit metric is more powerful?
Welcome to the battle of the acronyms. Both EBIT and EBITDA are profit metrics, and the good news is that each one is simpler than it sounds. So what do these chunks of jargon mean and which is more useful? The answer requires a quick recap on the nature of profit.
If you define profit as the revenue of a business that remains once you subtract its costs, the question becomes: which categories of costs do you deduct? There are several flavours of profit, depending on which expenses you include in this calculation. The difference between EBIT and EBITDA is that one metric allows for the falling value of long-term assets that the business owns (i.e. depreciation and amortisation) whereas the other does not. That’s it.
Is EBIT higher than EBITDA?
The clearest way to explain this point is to start with net profit, which is also known as net earnings. To determine this, you work out the revenue of the business for a period that remains once every cost is removed, including any interest owed or tax due.
Net profit = Revenue – Total costs
It’s helpful to add back the interest owed or tax due to calculate EBIT (i.e. Earnings Before Tax and Interest) as this metric focuses attention on factors more within the control of a business than its net profit. The EBIT figure is closely related to the operating profit, despite a few nuances.
EBIT = Net profit + Interest + Tax
The EBITDA metric (pronounced EE-BIT-DAH) goes one step further by adding back costs allowed for the depreciation and amortisation of assets. Depreciation is the amount shown on the income statement of a business for the decline in value of long-term assets, such as machinery. Amortisation is the same idea for intangible items, such as licenses.
EBITDA = Net Profit + Interest + Tax + Depreciation + Amortisation
Once we understand this idea, it’s obvious that EBIT has a lower value than EBITDA. The exception is if there is no depreciation or amortisation, in which case they would be equal.
Why is EBITDA useful?
If a business has a reliable operating income and substantial assets, which require hefty deductions for their depreciation or amortisation, the EBITDA is a measure of its profitability in a more meaningful sense. One example is an oil company, as it will have to spread the high costs of, say, its offshore rigs or drilling licenses over several years within its accounts.
As business managers have discretion over how to report these types of costs – for instance, the period over which it depreciates equipment – the EBITDA is, in some ways, more objective than other profit metrics. Because it strips-out so many non-cash expenses, the EBITDA also provides an indication of how much debt the business can handle.
Why is EBITDA preferred to EBIT?
Many businesses love to talk-up their EBITDA figure because it’s a larger sum than the EBIT and so it makes their profits look more substantive. Some people also believe that EBITDA provides insights into the cash position of the business. There is truth in this point, yet it is only an approximation and not a reliable way to measure the operating cash-flow.
The reality is that EBIT and EBITDA both have a role when you assess the performance of a business. Neither delivers a knock-out blow to its rival and so they should be used in tandem with each other, plus other profit metrics. It’s also worth noting that neither has a statutory definition within the UK, so it’s wise to check exactly what the bean counters have included.Sign up in minutes
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