Plus B: EBITDA and EBIT
Earnings Before (excluding) Interest and Tax
Earnings Before (excluding) Interest, Tax, Depreciation and Amortization
The acronyms are problematic. More accurately: Net Profit Without ...
Short Version:
EBIT and EBITDA are hypothetical profit figures. They are not Generally Accepted metrics and must therefore be defined in legal documents.
Analysts use them for two reasons:
(1) EBIT is roughly equivalent to Operating Profit. And
(2) EBITDA is a proxy for Operating Cash Flow.
EBIT: literally Earnings (net profit) Before (excluding) Interest incurred and Tax (income tax)
EBITDA: literally EBIT, but also excluding Depreciation and Amortisation (amortization).
Consider two breweries, one in Ireland, the other in Pennsylvania...
Earnings Before (excluding) Interest, Tax, Depreciation and Amortization
The acronyms are problematic. More accurately: Net Profit Without ...
Short Version:
EBIT and EBITDA are hypothetical profit figures. They are not Generally Accepted metrics and must therefore be defined in legal documents.
Analysts use them for two reasons:
(1) EBIT is roughly equivalent to Operating Profit. And
(2) EBITDA is a proxy for Operating Cash Flow.
- EBIT allows us to better compare the operating performance of companies with different capital structures and tax rates.
- EBITDA is used as a proxy for cash ow available to service borrowing. Lenders often use it as a guide to how much interest the company will be able to pay in future.
EBIT: literally Earnings (net profit) Before (excluding) Interest incurred and Tax (income tax)
EBITDA: literally EBIT, but also excluding Depreciation and Amortisation (amortization).
Consider two breweries, one in Ireland, the other in Pennsylvania...
Because they have different capital structures and tax strategies, which are largely the choice of management, the two businesses show quite different Profit After Tax (earnings) results.
EBIT is an indicator of a company's profitability, and is also sometimes referred to as "operating earnings", "operating profit" and "operating income", all of which are potentially very confusing - best to stick with EBIT. EBIT is essentially calculated as all profits before taking into account interest payments and income taxes. It became popular because of the way in which it essentially nullifies the effects of the company's capital structure and tax rate and thereby makes it easier for easier cross-company comparisons.
EBIT was the precursor to the EBITDA calculation, which goes further than EBIT by excluding depreciation and amortization expenses.
EBITDA is often used by financial analysts as a rough approximation of the company's available cash flows (but see commentary below).
EBITDA is essentially net profit but excluding interest, taxes, depreciation, and amortisation. It is used to compare profitability between companies and industries because it eliminates both the effects of financing (EBIT) and accounting decisions relating to depreciation and amortisation rates (DA). Companies using this measure have a greater deal of discretion as to what is and isn't included in the calculation which they can alter (to their favour?) from one reporting period to the next.
EBITDA started to be commonly used in the 1980s, during the glory days of leveraged buyouts, as it could indicate the ability of a company to service its debt. Later on, it also became popular in capital-intensive industries (ones with expensive assets) that had to be written down over long periods of time. Because the assets write downs (in the form of depreciation and amortisation) were typically very significant, they could tip the company into a net loss. By excluding the depreciation and amortisation, by magic the company looks like it is actually profitable. EBITDA is now commonly quoted by many companies, especially in the tech sector - even when it isn't warranted.
A common misconception is that EBITDA equates to cash earnings. EBITDA is a good metric to evaluate operational profitability, but you need to be careful with extending that to its cash flows. EBITDA does not show the impact of the cash required to fund working capital nor the replacement of equipment, which could be significant.
EBIT was the precursor to the EBITDA calculation, which goes further than EBIT by excluding depreciation and amortization expenses.
EBITDA is often used by financial analysts as a rough approximation of the company's available cash flows (but see commentary below).
EBITDA is essentially net profit but excluding interest, taxes, depreciation, and amortisation. It is used to compare profitability between companies and industries because it eliminates both the effects of financing (EBIT) and accounting decisions relating to depreciation and amortisation rates (DA). Companies using this measure have a greater deal of discretion as to what is and isn't included in the calculation which they can alter (to their favour?) from one reporting period to the next.
EBITDA started to be commonly used in the 1980s, during the glory days of leveraged buyouts, as it could indicate the ability of a company to service its debt. Later on, it also became popular in capital-intensive industries (ones with expensive assets) that had to be written down over long periods of time. Because the assets write downs (in the form of depreciation and amortisation) were typically very significant, they could tip the company into a net loss. By excluding the depreciation and amortisation, by magic the company looks like it is actually profitable. EBITDA is now commonly quoted by many companies, especially in the tech sector - even when it isn't warranted.
A common misconception is that EBITDA equates to cash earnings. EBITDA is a good metric to evaluate operational profitability, but you need to be careful with extending that to its cash flows. EBITDA does not show the impact of the cash required to fund working capital nor the replacement of equipment, which could be significant.