There are multiple metrics available to analyze the profitability of a company. EBIT and EBITDA are two of those metrics, and although they share similarities, the differences in their calculations can lead to varied results.
Earnings before interest and taxes (EBIT) is a company's net income before income tax expense and interest expense have been deducted. EBIT is used to analyze the performance of a company's core operations without tax expenses and the costs of the capital structure influencing profit.
The following formula is used to calculate EBIT:
EBIT=NI + IE + TEwhere:NI = Net incomeIE = Interest expenseTE = Tax expense
Since net income is a figure that doesn't include interest expense and tax expense, they need to be added back to calculate EBIT.
EBIT is often referred to as operating income since they both exclude taxes and interest expenses in their calculations. However, there are times when operating income can differ from EBIT.
Earnings before tax (EBT) reflects how much operating profit has been realized before accounting for taxes, while EBIT excludes both taxes and interest payments. EBT is calculated by taking net income and adding taxes back in to calculate a company's profit.
By removing tax liabilities, investors can use EBT to evaluate a firm's operating performance after eliminating a variable outside of its control. In the United States, this is most useful for comparing companies that might have different state taxes or federal taxes. EBT and EBIT are similar to each other and are both variations of EBITDA.
EBITDA or earnings before interest, taxes, depreciation, and amortization is another widely used indicator to measure a company's financial performance and project earnings potential.
EBITDA strips out debt financing as well as depreciation, and amortization expenses when calculating profitability. It also excludes taxes and interest expenses on debt. As a result, EBITDA helps to drill down to the profitability of a company's operational performance.
EBITDA can be calculated by taking net income and adding back interest, taxes, depreciation, and amortization whereby:
EBITDA=NP + I + T + D + Awhere:NP = Net profitI = InterestT = TaxesD = DepreciationA = Amortization
Comparing EBIT and EBITDA
Below is a portion of the income statement for JC Penney's as of May 5, 2018.
JC Penney's EBIT:
- Net income was a loss for -$78 million, highlighted in blue.
- Interest expense was $78 million while tax expense was a $1 million credit, highlighted in green.
- EBIT was $1 million for the period or -$78 million (net income) - $1 million (taxes) + $78 million (interest).
- Since income tax was originally a credit of $1 million, we deducted it back out to calculate EBIT.
JC Penney's EBITDA is calculated using net income as well:
- Net income was -$78 million, highlighted in blue.
- Depreciation was $141 million, highlighted in red.
- Net interest expense was $78 million while taxes were +$1 million, highlighted in green.
- EBITDA was $140 million or -$78 million + $141 million - $1 million + $78 million (net interest).
- Again, income tax was originally a credit of $1 million, so we deducted it back out to calculate EBITDA.
We can see from the example above that EBIT of $1 million was entirely different from the EBITDA figure of $140 million. For JC Penney, depreciation and amortization add a significant amount to profits under EBITDA.
Considerations with EBIT and EBITDA
Both EBIT and EBITDA strip out the cost of debt financing and taxes, while EBITDA takes it another step by putting depreciation and amortization expenses back into the profit of a company.
Since depreciation is not captured in EBITDA, it can lead to profit distortions for companies with a sizable amount of fixed assets and subsequently substantial depreciation expenses. The larger the depreciation expense, the more it will boost EBITDA.
EBITDA can also be calculated by taking operating income and adding back depreciation and amortization. Please note that each EBITDA formula can result in different profit numbers. The difference between the two EBITDA calculations may be explained by the sale of a large piece of equipment or investment profits, but if that inclusion is not specified explicitly, this figure can be misleading.
The Bottom Line
EBIT and EBITDA are both important metrics in analyzing the financial performance of a company. The differences in profitability in our example shows the importance of using multiple metrics in the analysis. (For more profit analysis, please read "How Do Gross Profit and EBITDA Differ?" and "How Are EBIT and Operating Income Different?")