EBIT vs EBITDA | A comparison

EBIT (Earnings Before Interest and Taxes) and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) are both important financial metrics used to assess a company’s profitability.

In this article, we examine the differences between the two ratios and provide guidance as to when it is best to use which of the two ratios when analyzing companies.

EBIT (Earnings Before Interest and Taxes):

EBIT represents a company’s net income before accounting for income taxes and interest expenses.

Purpose

It allows us to analyze the performance of a company’s core operations without the influence of tax expenses and the costs of the capital structure.

Calculation

EBIT starts with net income and adds back interest and taxes.

When To Use EBIT?

EBIT focuses solely on operating profitability by excluding interest and taxes. It provides insight into a company’s core operating performance. Use it when you want to assess profitability without considering the impact of capital structure (debt vs. equity).

For example, when comparing two companies with different debt levels, EBIT allows a more direct comparison of their operational efficiency.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization):

EBITDA reflects a company’s operational performance by excluding deductions for capital assets, interest, and taxes.

Purpose

It provides insight into a company’s profitability before considering depreciation and amortization expenses.

Calculation

EBITDA starts with net income and adds back interest, taxes, depreciation, and amortization.

When To Use EBITDA?

Use EBITDA when evaluating companies with varying levels of fixed assets or when assessing their ability to cover debt payments. It is commonly used in valuation models (such as EV/EBITDA multiples) because it reflects the entire operating cash flow available to all stakeholders (debt and equity holders). For capital-intensive businesses, EBITDA provides a clearer picture of cash flow available for debt servicing.

Key Differences:

Depreciation and Amortization:

• EBIT does not add back depreciation and amortization expenses.
• EBITDA specifically includes these expenses.

Operating Performance Comparison:

• EBITDA provides an apples-to-apples comparison of operating performance by excluding depreciation.
• EBIT may yield different results when comparing companies with varying levels of fixed assets.

Interchangeability with Operating Income:

• EBIT is sometimes used interchangeably with operating income, although they can differ.
• Operating income excludes gains or losses from non-core activities, while net income (used in calculating EBIT) does not.

Comparison with Earnings Before Taxes (EBT):

• EBIT and EBITDA are distinct from earnings before taxes (EBT), which reflects operating profit before accounting for taxes.
• EBT allows evaluation of a firm’s performance after eliminating a variable outside its control (tax liabilities).

In summary, EBIT focuses on core operations without considering depreciation, while EBITDA provides a broader view by including depreciation and amortization. Both metrics are valuable tools for assessing a company’s financial health.