Sunday, June 26, 2022

EBIT vs EBITDA: What’s the Difference?

Hey there I'm James you're watching AccountingStuff and in this video i'll explain what EBIT and EBITDA both mean how you can calculate them andwhy they're important if you're one of my regular viewers then you might have noticedthat i'm saton a different sofa and that's because i've moved yep i've been living in Vancouver for the lastfew years but now i'm in Sydney which is actually where i used to live before i lived in Vancouverthat's a fun fact for you anyways let's jump right in what do EBIT and EBITDA both mean?EBIT andEBITDA are two ways of measuring a business's profitability they are both acronyms EBIT standsfor earnings before interest and taxes and EBITDA is very similar it stands for earnings beforeinterest, taxes, depreciation and amortization so where can you find EBIT and EBITDA on financialstatements?they both live in the income statement.

This is the financial statement which summarizesabusinesses revenues and expenses over a period of time revenue less expenses is profit andlike i mentioned EBIT and EBITDA are both measures of profitability so how can wecalculate EBIT?EBIT stands for earnings before interest and taxes and when we say earnings wemean profit you can find a business's net profit on the bottom line of income statement so this isgoing to be our starting point for the calculation before means that we're going to add back andwhat are we going to add back? interest and tax interest expenses are the cost of borrowingmoney it's a non-operating cost so it sits below operating profit and tax expenses are what thebusiness reckons it owes to the local tax authority for this accounting period so we cancalculate EBIT earnings before interest.

And taxes by taking a business's net profit andadding back the interest and tax expenses this is our formula and we'll come back to it inthe example but how can we calculate EBITDA? it's a very similar process EBITDA meansearnings before interest, taxes, depreciation and amortization so we start with net profit and addback interest and taxes just like we did for EBIT but this time we're going to go a step further byadding back depreciation and amortization as well depreciation expenses are the cost of reducingthe book value of tangible assets those are assets that you can touch this is because of use wearand tear the passing of time or obsolescence and amortization is very similar it's the costof reducing the book value of intangible assets assets that you can't touch so EBITDAearnings before interest, taxes, depreciation and.

Amortization is equal to a business's net profitplus interest expenses and tax expenses plus any depreciation and amortization incurred during theyear time for an example Firkenflop is a company that makes sandals which can be paired withwoolly socks for a sublime combination of comfort and style here's their income statement for theyear ended 31st of december how do we calculate Firkenflop's EBIT their earnings before interestand taxes well we know that EBIT is equal to net profit plus interest expenses and tax expensesduring the year Firkenflop made a net profit of 1.21 million dollars so if we add back theirinterest expense of 140 thousand dollars and their tax expense of two hundred and fifty thousand dollarsthen Firkenflop's EBIT is 1.6 million dollars simples but hold on a moment there's aneasier way 1.6 million dollars is exactly the same.

As Firkenflop's operating profit this is nocoincidence because EBIT and operating profit are the same thing most of the time anyway now thatwe've done and dusted EBIT how can we calculate Firkenflop's EBITDA their earnings beforeinterest, taxes, depreciation and amortization EBITDA is equal to net profit plus interestexpenses plus tax expenses plus depreciation plus amortization Firkenflop made a net profit of1.21 million dollars so we need to add back their interest expense of 140,000 dollars their tax expenseof 250,000 dollars and on top of all of this we add back their depreciation and amortization of one milliondollars that means that Firkenflop has an EBITDA of 2.6 million dollars given that EBIT andoperating profit are almost always the same a shortcut to working this out would be to saythat EBITDA is equal to operating profit plus.

Depreciation and amortization Firkenflop has anoperating profit of 1.6 million dollars so if we add back their depreciation and amortizationincurred for the year of one million dollars then we can see that their EBITDA is 2.6 milliondollars the same as we had before if you find it hard to remember these equations for EBIT andEBITDA then you can support this channel by buying my profitability ratios cheat sheet the links inthe description but hold up what if you want to work out EBITDA but you can't find depreciationor amortization in the income statement this can happen from time to time depreciationmight be wrapped up in cost of goods sold if it's linked to production of inventory if that's thecase then there's no need to fret take a peek at the business's cash flow statement instead if it'sbeen prepared under the indirect method which is.

Very likely then depreciation and amortization canbe found under cash flow from operating activities they're both added back to net profit sincethey are non-cash expenses now we know what EBIT and EBITDA both stand for, what they mean, where tofind them and how to calculate them that leaves just one more question why do we bother?why can't we use net profit to measure profitability? the problem with net profit is that it's beeninfluenced by indirect variables that sit outside of a business's core operations for exampleinterest is the cost of borrowing money which is determined by a business's capital structure andtax it varies by location maybe we want to compare companies that are based in two different statesor countries if we remove all these interest and tax expenses then we're left with EBIT which keepsthe focus on the business's operating efficiency.

EBITDA goes one step further it ignoresdepreciation and amortization which are the costs of capital investments if we strip them out aswell then you can get a feel for how much profit the business is able to make doing what it doeslike selling sandals in the case of Firkenflop and since depreciation and amortization are bothnon-cash expenses EBITDA is also a quick way to estimate if a business can pay its debts when theyfall due huge thanks to all my channel members for supporting Accounting Stuff your contributionsare greatly appreciated see you in the next one


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