While executing a company valuation investor always use multiple metrics for analyzing the company’s performance. Both EBIT and EBITDA are part of those metrics. Now we will discuss the key characteristics of the EBIT and EBITDA.
EBIT: - EBIT is also known as Operating Profit. EBIT is defined as a company’s net profit including all types of expenses or expenditure, but it does not include income tax expenses and interest expenses in it.
The Formula for calculating EBIT are:
EBIT = Operating Revenue – Operating Expenses
EBITDA: - EBITDA is defined as any company’s net profit which includes all types of expenses or expenditure, but it does not include income tax expenses, interest expenses, depreciation and amortization expenses in it.
The Formula for calculating EBITDA are:
Operating profit + Depreciation and Amortization expenses
Key differences between EBIT and EBITDA
- EBIT illustrates a company’s operating earnings before interest and tax expenditure, but EBITDA depicts a company’s incomes priors to any amortization or depreciation.
- EBIT represents the company’s income that comprises all kinds of expenditure except income tax and interest expenditures, but EBITDA represents a firm’s real operating performance devoid of any concealed expenses such as depreciation, amortization, etc.
- EBIT illustrates operating results on an accumulation basis, but EBITDA illustrates operating results based on cash flows.
Examples of EBIT Vs. EBITDA
Example – Now consider there’s a construction company which accumulated $100,000 in last year and the company’s operating expenditures were recorded at $65,000. Then, EBIT will be $35,000. The expenses were administrative, general, selling, COGS, and so on. Now, we will extend the example for calculating EBITDA with key assumptions including, working lifetime expectation for the asset of 15 years. Now suppose that the company bought the machinery some time back had the consolidated value of $25000 with a working life of 15 years. In that case, by applying linear depreciation, the machinery would together depreciate by $25000/15. Then we will get $1666.70 per year.
After the calculation of depreciation, we will look for the amortization expenses. Typically, amortization expenditures are recorded in line with depreciation expenditures on any company’s Income statements or cash flows statements. Now, we assume that some time ago a company obtained the rights for some famous song for $5,000 so that it can be used in the commercials and it was purchased for say six years. Then Amortization expense will be $5000/6 = $833.33 per year.
Now we will calculate EBITDA. In this, we will add the overall expenditures to the firm’s EBIT. For calculating EBITDA for a construction company, we will add the depreciation and amortization expenditure with the operating profit of the company. In this case, EBITDA of the construction will be calculated by adding the company’s EBIT with firm’s depreciation and amortization, i.e., 833.33+1666.70+35000. The company’s EBITDA calculated to be $37,500.03.
Both ratios are used for checking the firm’s operational efficiency. If a company shows an uptrend in these ratios, then it means the company’s operational efficiency is going upward.
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