EBIT vs. EBITDA

EBIT vs. EBITDA: What are the Similarities?

EBIT and EBITDA are acronyms for the following:

• EBIT → “Earnings Before Interest and Taxes”
• EBITDA → “Earnings Before Interest, Taxes, Depreciation and Amortization”

In practice, EBIT and EBITDA are two of the most prevalent metrics, particularly for performing valuation analyses, such as in the context of fundamental investing in the public markets and mergers and acquisitions (M&A) transactions.

The commonalities shared between EBIT and EBITDA are as follows.

• Pre-Interest Metrics → The calculation of EBIT and EBITDA is prior to any deductions related to interest. Interest, or more specifically interest expense and interest income, are discretionary items that pertain to the company’s specific capital structure (i.e. the particular mix of debt and equity used to fund operations). For example, two comparable companies can finance their operations using different sources of funding based on management discretion. The two companies can also allocate the “excess” cash differently, such as placing cash in low-yield cash accounts or issuing dividends to shareholders. The point to understand here is that interest is a non-operating item, i.e. it is not part of the core business activities.
• Pre-Tax Metrics → The formula to compute EBIT and EBITDA are each on a pre-tax basis. In effect, neither metric is affected by the income taxes paid to the government, which is jurisdiction-dependent and impacted by company-specific factors, such as deferred taxes (DTAs/DTLs) and net operating losses (NOLs) sitting on the balance sheet. Similar to interest, taxes are also considered a non-operating item, despite the fact that paying taxes is a recurring mandatory obligation.

Because EBIT and EBITDA are each independent of discretionary capital structure decisions (i.e. the financing mix) and pre-tax measures of profitability, they can be used for comparability purposes between different companies.

EBIT vs. EBITDA: What are the Key Differences?

So, what are the key differences between EBIT and EBITDA, and which metric is better?

The most straightforward difference between EBIT and EBITDA is that the latter is adjusted to add back non-cash expenses like depreciation and amortization (D&A)

In the calculation of EBIT, revenue is adjusted by cost of goods sold (COGS) and operating expenses, which include the depreciation and amortization (D&A) expense embedded within COGS and Opex.

Where:

The EBIT formula deducts COGS and operating expenses, including the required accounting convention related to Capex (i.e. the depreciation expense), but does not directly deduct Capex.

In contrast, the calculation of EBITDA deducts from revenue the cost of goods sold (COGS) and operating expenses (SG&A) incurred by a company, but not non-cash items (D&A).

While EBITDA also deducts COGS and operating expenses, Capex is neglected in its entirety. Like EBIT, the initial outlay from the Capex is ignored, yet EBITDA also removes the effects of the depreciation expense.

The exclusion of the D&A expense in the case of EBITDA, contrary to EBIT, is thereby the primary distinction between these two profit metrics.

The depreciation and amortization (D&A) expense is recorded on the income statement per GAAP reporting guidelines to “match” the timing of the expense recognition with the monetary benefits retrieved from the fixed asset (PP&E) and intangible asset.

Yet, the actual cash outlay from the purchase of the long-term asset – i.e. the capital expenditures (Capex) – was incurred on the date of the original purchase.

EBIT vs. EBITDA: Which is a GAAP and Non-GAAP Measure?

The discretionary adjustment to compute EBITDA – where the depreciation expense is treated as a non-cash add-back – is the reason EBITDA is a non-GAAP measure.

EBIT is an accrual-accounting-based measure of profitability prepared under U.S. GAAP standards, whereas EBITDA is a non-GAAP, hybrid profit measure.

Unlike EBIT, which is recorded on the income statement most often as either “Operating Income” or “Operating Profit”, the reconciliation of EBITDA is reported separately in filings, earnings reports, and management presentations.

However, EBITDA is not a line item on the income statement prepared under U.S. GAAP reporting.

EBITDA must be calculated manually, starting with the add-back of depreciation and amortization (D&A).

The D&A expense is typically embedded in the COGS and operating expenses section of the income statement (and seldom broken out), so the full D&A value must usually be obtained from the cash from operations section of the cash flow statement (CFS).

EBIT vs. EBITDA: Which is Better?

The magnitude of the difference between EBIT vs. EBITDA is contingent on the industry in which the company in question operates, including other discretionary management decisions.

For example, the useful life assumption of fixed assets (PP&E) and management’s efficiency at capital spending (or lack thereof).

The variance between EBIT and EBITDA is further expanding as of late due to the rise in usage of the “Adjusted EBITDA” metric, which is the traditional EBITDA metric but with even more discretionary adjustments.

The rationale for applying the adjustments to EBITDA, at least in theory, is to portray a company’s operating performance more accurately to offer investors more transparency.

The risk here is that greater management discretion and less standardization create more “room” for questionable adjustments and the risk of earnings manipulation to paint a misleading picture of the current state of a company’s profitability.

EBITDA tends to be more useful for analyzing capital-intensive companies or those with substantial intangible assets (and amortization expenses).

If EBIT were to be used, there could be a misguided interpretation that the company was incurring steep losses when, in actuality, those are non-cash expenses.

On that note, the usage of EBITDA is more common in the context of M&A transactions because the cash flow profile of the target is what is being negotiated (and amicable adjustments can be determined).

EBIT vs. EBITDA: Which is Higher?

EBIT and EBITDA metrics are frequently used to perform relative valuation, in which the two metrics coincide with the enterprise value (TEV) metric.

Why? For a valuation multiple to be practical, the numerator (i.e. the value measure) and denominator (i.e. the value driver) must match concerning the stakeholders represented.

Hence, EBIT and EBITDA both correspond to enterprise value, rather than equity value, since the profit metrics have not yet been adjusted for any payments to lenders, namely the periodic interest expense payment owed on outstanding debt.

Two of the most common valuation multiples used in relative valuation – such as comparable companies analysis (or “trading comps”) and precedent transactions analysis (or “transaction comps”) – are EV/EBITDA and EV/EBIT.

Generally, the insights derived from either multiple will be marginally different, albeit there are times in which a sizable depreciation and amortization expense can cause a discrepancy in the multiples.

But in such scenarios – most often with capital-intensive companies that operate in the manufacturing, transportation sector, or the airline industry – other industry-specific valuation multiples like EV/EBITDAR would be more appropriate.

The aforementioned instances are outliers, however, so EV/EBIT and EV/EBITDA are most often displayed side-by-side on a comps sheet.

EBITDA is greater than EBIT in practically all cases since non-cash charges like D&A are added back.

Thus, the EV/EBIT multiple will be higher than EV/EBITDA, considering the denominator is of lesser value.

EV/EBIT is thus perceived as the more conservative valuation multiple, especially to critics who view EBITDA as a flawed measure of profitability.

Likewise, the interest coverage ratio – especially when measured by risk-averse bank lenders that prioritize capital preservation and reducing the potential for capital losses – is far more likely to use EBIT instead of EBITDA for the same reason, i.e. EBIT is a more conservative measure of profitability.

EBIT vs. EBITDA Calculator

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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1. EBIT vs. EBITDA Calculation Example

Suppose you’re tasked with calculating the EBIT and EBITDA of a company given the following income statement from fiscal year 2022.

Upon subtracting the company’s operating expenses – the SG&A and R&D expenses – from gross profit, our company’s EBIT comes out to be $40 million.

• EBIT = $120 million – $60 million – $20 million = $40 million

From there, we’ll standardize the company’s EBIT into a percentage by dividing the GAAP profit metric by revenue, which yields an operating margin of 20.0%.

• Operating Margin (%) = $40 million ÷ $200 million = 20.0%

The 20.0% operating margin implies that the company generates $0.20 in operating income (or EBIT) per dollar of revenue earned.

2. EBIT to EBITDA Calculation Example

The next part of our quick modeling exercise comprises the reconciliation of EBIT (GAAP) into EBITDA (Non-GAAP).

For our depreciation and amortization (D&A) assumption, we’ll assume the annual D&A expense recognized on the income statement in FY-2022 was $10 million.

• Depreciation and Amortization (D&A) = $10 million

The EBITDA of our company can be determined by adding the D&A expense – which we’ll assume to have pulled from the cash flow statement (CFS) – to EBIT from the income statement.

Since EBIT in FY-2022 is $40 million, whereas the incurred D&A expense is $10 million, we arrive at an EBITDA of $50 million.

• EBITDA = $40 million + $10 million = $50 million

Like earlier, we’ll divide the company’s EBITDA by revenue to calculate the EBITDA margin.

• EBITDA Margin (%) = $50 million ÷ $200 million = 25.0%

The EBITDA margin amounts to 25.0%, which reflects a 5.0% differential compared to the operating profit margin.

With that said, for each dollar of revenue generated, the company earns $0.25 in EBITDA.

The non-operating items recorded on the income statement, such as interest and taxes, are not part of the calculation for either EBIT or EBITDA, which reiterates how the two metrics are capital structure neutral and unaffected by taxes.

Like EBIT, EBITDA is capital structure independent and not affected by taxes. The treatment of D&A as a non-cash charge, however, is what causes the difference between our hypothetical company's EBIT and EBITDA ($40 million vs. $50 million).