2 min
Understanding a company's financial health and operational performance involves delving into various profitability metrics. Two of the most essential tools analysts and investors use are EBIT and EBITDA. Here's a breakdown of what they are and why they matter:
What it is: EBIT reflects a company's core operating profitability by stripping out the impact of financing choices (interest) and tax jurisdictions.
Calculation Start with net income from the income statement and add back: Interest expense Income tax expense
How it's used:
Measure of operating performance: EBIT isolates the profitability generated from the company's core business operations.
Comparing companies with different debt levels: It's useful for comparing companies with different capital structures (how much debt vs. equity financing they use).
A proxy for Operating Income: In some cases, EBIT can be synonymous with a company's reported Operating Income.
What it is: EBITDA further removes the impact of non-cash expenses (depreciation and amortization) on top of the exclusions used in EBIT. This offers a higher-level view of a company's cash-generating potential.
Calculation Start with net income from the income statement and add back: Interest expense Income tax expense Depreciation expense Amortization expense
How it's used:
Rough estimate of cash flow: EBITDA serves as a very crude approximation of operating cash flow (though still needs significant adjustments).
Comparing companies with significant fixed assets: EBITDA is popular for evaluating businesses that are asset-heavy (manufacturing, telecom), since depreciation expenses can create wide variations in EBIT, obscuring operating potential.
Popular in valuation multiples: Used in multiples like Enterprise Value / EBITDA.
Key Differences: Depreciation and Amortization
The fundamental difference between EBIT and EBITDA lies in their treatment of non-cash expenses:
Depreciation: The systematic allocation of a fixed asset's cost over its useful life.
Amortization: Similar to depreciation, but applied to intangible assets (patents, trademarks, etc.).
By excluding depreciation and amortization, EBITDA paints a potentially rosier picture of a company's financial health than EBIT.
The choice between EBIT and EBITDA depends on the purpose of your analysis:
Operating profitability: If you want a clearer picture of core operating performance, with the impact of asset lifecycles accounted for, EBIT is better.
Cash flow potential: If you're focused on a company's ability to generate cash, especially for debt repayment or acquisitions, EBITDA might be more relevant (but keep in mind it still requires adjustments to get to true cash flow figures).
Comparative analysis: In asset-heavy industries, EBITDA is the preferred metric for comparisons across companies, since it reduces the distortion caused by different depreciation policies.
Cautions
EBITDA isn't GAAP: EBITDA is a non-GAAP (Generally Accepted Accounting Principles) measure, so it can be less reliable and consistent.
EBITDA can be misleading:. EBITDA hides real costs of running a business (replacing assets). When used in isolation, it may inflate a company's financial health.
Always consider both EBIT and EBITDA (alongside other metrics) for a well-rounded view of a company's financial performance.