What Is the Difference Between EBITDA and Operating Income?
EBITDA, a commonly used finance acronym that stands for “Earnings Before Interest, Taxes, Depreciation, and Amortization” measures a company's profitability and is typically used to determine a business’ earnings potential.
EBITDA removes from consideration the costs of debt financing as well as depreciation and amortization expenses from the profit equation. Consequently, EBITDA shows a company's profit without taxes and interest expenses on any debt it may have on its balance sheet. EBIDTA greatly benefits investors by providing a stripped-down view of a company's profitability from its core operations.
Operating income measures a company's profit after subtracting operating expenses, including outgoing general and administrative costs. Similar to EBITDA, operating income conveys how much profit (gross income) a company generates from its operations alone, without taking interest expenses or tax expenses into account.
Comparing EBITDA and Operating Income
EBITDA maybe calculated with the following formula: :
EBITDA = Operating Income + Depreciation and Amortization
The difference between EBITDA and operating income may be best understood by studying a real income statement data, such as the following information from JC Penney Company Inc. (JCP) as of May 05, 2018:
- Operating income was $3 million, highlighted in blue.
- Depreciation was $141 million, but the $3 million in operating income includes subtracting the $141 million in depreciation and amortization. As a result, depreciation and amortization are added back into operating income during the EBITDA calculation.
- EBITDA was $144 million for the period or $141 million + $3 million.
- We can see that interest expense and taxes are not included in operating income, but instead, are included in net income.
JC Penney's EBITDA of $144 million was quite different from its operating income of $3 million during the same period. When comparing EBITDA and Operating Expenses, one metric is not necessarily better than the other. Instead, they both show the profit of the company in different ways, by stripping out and inputting different numbers.
Operating income includes overhead and operating expenses as well as depreciation and amortization. However, operating income does not include interest on debt and tax expense. With EBITDA, non-cash items like depreciation, taxes, and capital structure are stripped from the EBITDA equation.
It's important for investors to use multiple profit metrics when analyzing the financial statements of a company. While EBITDA helps avoid the effects of possible management manipulation by removing debt financing, operating income can help analyze the production efficiency of a retailer's core operations and expense management.
For more on the different ways to calculate EBITDA including using net income, please read "What Is the Formula for Calculating EBITDA?"