EBIT (earnings before interest and taxes) and EBITDA (earnings before interest, taxes, depreciation, and amortization) are two indicators of the profitability of a company. They can usually be found on an income statement (also referred to as a profit and loss statement). As their names suggest, they are related terms, and both are named for what they don’t include.
Whereas net income is the final profit of a company after all expenses have been paid, EBIT does not include interest and taxes while EBITDA further doesn’t include depreciation and amortization.
The reasons for measuring and reporting these further totals, even though they are not GAAP (Generally Accepted Accounting Principles) approved, is clear. Interest, taxes, depreciation, and amortization are all very different from the kinds of expenses we normally think about, so it gives useful information to remove them in different ways.
In this article, we will look at EBIT and EBITDA, what makes them similar, what makes them different, how they are calculated, where they can be found, and what information can be drawn from EBIT and EBITDA.
EBIT (earnings before interest and taxes) is an indicator of a company’s operating profitability. It excludes interest and taxes for two related reasons.
Interest is excluded to give the company a “debt-agnostic” view of their profitability. That is, it shows how the profitability of the company would look without having to pay for debt financing. This is done because paying interest on debt isn’t really related to the operations of a company.
Similarly, taxes are excluded to give the company a “taxes-agnostic” (or jurisdiction-agnostic) view of their profitability. Since taxes often change from one year to the next, or from one location to the next, understanding the profitability of a company before the government is involved gives a clearer view of the decision making of a company, i.e., the profitability of the internal decision making of the company.
Thus, by looking at the profitability with these two special expenses removed, EBIT presents the underlying profitability of the company.
EBIT can be calculated in two different ways. The first method is additive, while the second is subtractive.
In the first method, the bottom line of the income statement, i.e., net income, is added to the interest expenses and taxes. Effectively, this is working backwards from the final number by re-adding the two excluded expenses back:
EBIT = Net Income + Interest Expenses + Taxes
The second method starts with the net sales revenue and subtracts the expenses other than interest expenses and taxes. These include COGS (cost of goods sold) and operating expenses:
EBIT = Sales revenue – COGS – operating expenses
Interestingly, if EBIT is calculated using the second method, then it is always equal to operating income as defined by GAAP, but that is not always the case with the first method because net income can include non-operating income and/or expenses.
Check out: Bookkeeping for Your SaaS Business
EBITDA (earnings before interest, taxes, depreciation and amortization) is another measure of business profitability. Similar to EBIT, it excludes taxes and interest expenses for the same reasons as above. In addition to taxes and interest expenses, it also removes depreciation and amortization.
Depreciation and amortization are non-cash expenses that turn tangible and intangible assets into expenses, respectively.
Tangible assets include the things of value owned by your company that you can touch. This is anything from a laptop or desk to a building or plot of land.
Conversely, intangible assets are anything of value owned by your company that you cannot touch. Intangible assets include your brand name, the relationships you have with customers as well as their signed contracts, and your platform.
Most tax jurisdictions allow you to take the cost of these major purchases and spread their value out over many accounting periods. Since they are non-cash expenses, they affect your income statement but not your statement of cash flows.
For this reason, calculating your EBITDA can help show the true financial health of your SaaS enterprise.
While revenue and EBITDA are both essential to operating an efficient company, they are slightly different. EBITDA is the total income, minus operating expenses. Revenue is the total income before deducting any expenses. In other words, EBITDA is your cleaned revenue that you can use to identify how your company’s health is progressing.
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EBITDA can be calculated following two different additive methods. They both follow the pattern of the first method of calculating EBIT only adding back more of the items subtracted from revenue to calculate your net income.
The first method can be used when you don’t calculate your EBIT, while the second can be used when you do calculate your EBIT.
In the first method, you start with your net income and then add back the four excluded expenses of interest expense, taxes, depreciation, and amortization:
EBITDA = Net Income + Interest Expense + Taxes + Depreciation + Amortization
In the second method, you use your EBIT calculated previously according to either of the methods above as a shortcut. In this case, you only need to add back your non-cash expenses:
EBITDA = EBIT + Depreciation + Amortization
In the EBIT vs. EBITDA debate, neither comes out ahead as they both give different information, calculating both doesn’t take that much more time than calculating only EBIT or only EBITDA, and the information required to calculate them is all found in the same place (your income statement).
Whereas EBIT is a measure of operating income, EBITDA is a measure of how your profitability is affected by non-cash expenses.
When it comes to easy-to-calculate metrics, it is valuable to have as many as possible. When it comes to hard-to-calculate ones, the same is true, but don’t waste your time doing the calculations by hand.
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EBIT and EBITDA are highly related metrics, but they also have some key differences. Let’s look at their similarities and differences.
The following are some of the similarities of EBIT and EBITA:
The following are some of the differences between EBIT and EBITDA:
EBITDA can be preferred to EBIT in two specific cases.
First, as mentioned above, when a company has heavily invested in tangible or intangible assets, they have high depreciation or amortization expenses, respectively, which can drastically reduce their net income. In this case, their EBITDA might be a better indicator of their long-term viability.
Second, when a company is being acquired, the purchaser might be more interested in their EBITDA than their net income since the non-cash expenses have already been paid and do not necessarily affect the future profitability of the acquisition target.
Read also: How to categorize expenses in a SaaS startup
Every company has a different structure, and which metrics best reflect the financial health of that company will change accordingly. While calculating dozens of financial metrics by hand is a distraction, the more information you have at your fingertips while making strategic decisions, the better.
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