Are you a business owner? Do you know the ins and outs of the financials of your business? Knowing your business inside and out ensures your company runs smoothly and can grow.
If you are running a business, you will likely come across EBIT and EBITDA. These terms measure similar things, as they both refer to the profitability of your business. However, some slight differences allow them to estimate profitability in varied ways.
To help you know everything about these concepts, we’ll give you the full rundown, including what they are and how to calculate them. We’ll also tell you when to use them and which measurement is best.
What Is EBIT?
As mentioned earlier, EBIT is a way to measure your organization’s profitability. EBIT stands for Earnings Before Interest and Taxes. If you use EBIT, you will know how your business is operating without the interference of the money spent on taxes and paying off debt using our PPP loan forgiveness simplification.
EBIT is a key calculation because it shows how much your company earns from its production and sales. Knowing the productivity of your business is vital because it allows you to see how your business will run in the future.
The EBIT score of your business is advantageous for you to know. However, investors will also be curious about your EBIT score, as your company profitability is crucial information to give someone looking to buy into it.
Many times, a company’s net income can be deceiving as taxes and debt change. It is vital to take away these factors and look purely at profitability for both business owners and investors.
EBIT Formula: How to Calculate
Calculating EBIT is simple. One way to calculate EBIT is to add your net income, interest, and taxes. You must add interest and tax costs to net income because those expenses are not related to productivity.
Another way to calculate EBIT is to subtract your COGS (Cost of Goods Sold) and operating expenses from revenue. You need to subtract the cost of goods sold and operating expenses from your revenue because these expenses are related to productivity.
Cost of goods sold refers to the amount of money it takes to make your product, including the materials used. Operating expenses are costs like employee wages, the cost to repair machines, marketing, etc.
The EBIT formula will look like this:
Net Income + Interest + Tax = EBIT
Revenue – COGS – Operating Expenses = EBIT
If you see that the EBIT formula yields different results when you try to calculate EBIT for your business, do not panic. These equations provide an estimate. You use different financial aspects for each, so you will likely get a slightly different number.
EBITDA Meaning- What It Is
Like EBIT, EBITDA is another way to measure the profitability of your business. EBITDA stands for Earnings Before Interest, Taxes, and Depreciation and Amortization.
Depreciation refers to the value of an asset over time. Usually, assets will decrease in value over time. Amortization is similar to depreciation. It refers to the cost of an asset over time.
So, the EBITDA meaning is similar to EBIT but does not include money lost to depreciation and amortization. Some believe that using EBITDA as a measure gives an inaccurate depiction of a business’s profitability. If a firm has many fixed assets, not including depreciation in the calculation of earnings can create an inaccurate picture of their profits.
How to Calculate EBITDA
Calculating EBITDA is slightly more complicated than calculating your EBIT, but it is still relatively simple. Like EBIT, there are two principal ways to calculate EBITDA.
The first way to calculate EBITDA is to add operating income and depreciation and amortization. Operating income refers to the earnings of a company after operating expenses.
The second way to calculate EBITDA is to add net income, taxes, interest expense, depreciation, and amortization.
EBITDA calculations will look like this:
Operating Income + Depreciation and Amoritization = EBITDA
Net Income + Taxes + Interest Expense + Depreciation and Amoritization = EBITDA
Like the EBIT equations, you may get different EBITDA values if you try each formula. Again, each is just a close estimate, and both numbers will give you an idea of the profitability of your business.
EBIT vs EBITDA: When to Use
Because EBIT and EBITDA are so similar, it is sometimes difficult to know when it is appropriate to use EBIT vs EBITDA. Generally, you can use either to measure the profitability of your business. You can also calculate them side by side and compare the numbers. Knowing the EBIT vs EBITDA margin is very helpful in seeing your profitability.
If your company has fewer fixed assets, you may prefer using EBIT. On the other hand, a company with more fixed assets may favor EBITDA. Just as applying for a small business loan can affect your credit score, the number of fixed assets you have can help you determine whether EBIT or EBITDA is better for your business.
However, as both calculations are crucial to determining profitability, you may want to look at both every so often. Each can tell you useful information about the operations of your business and including EBITDA and EBIT on income statements can help you apply for loans or receive tax breaks.
EBIT vs EBITDA: Which Is Better
While it is hard to say which is better overall in the competition of EBIT vs EBITDA, different people prefer them for varied purposes. However, some believe that EBITDA inaccurately portrays companies’ profitability because it adds back depreciation.
If a company operates with many fixed assets, it can make them look like they are doing better than they are. So, some investors prefer the EBIT measure for that reason.
That said, companies with more fixed assets may prefer EBITDA as a measure because their numbers will likely be better. So, although some investors do not like it, EBITDA is generally preferred by business owners.
Hopefully, you better understand EBIT and EBITDA and how these calculations can help your business. Neither measure is superior, but both can be important for evaluating business productivity.
Although these values can be significant, there are other essential calculations to determine the success of your business. Your EBIT or EBITDA result will not make or break your profits; they’re just helpful tools that can allow you to see what you need to work on to make your company a success.