Terms Of The Trade: EBIT And EBITDA

Financial and accounting acronyms can be confusing and daunting, but they don't have to be.

Two of the most commonly used acronyms that publicly companies reference is EBIT and EBITDA. EBIT refers to a company's Earnings Before Interest & Tax, while EBITDA refers to a company's Earnings Before Interest, Taxes and Amortization Depreciation.

EBIT measures a company's profitability before taking into consideration its cost of capital or tax implications. The EBIT figure is already tabulated by the company and included in its income statement.

Investors would look at the EBIT figure to gain a better understanding of a company's operating performance without considering taxes and other unavoidable interest expenses.

EBIT is particularly useful when comparing companies in a similar industry since each organization has different capital structures and tax rates.

EBITDA Explained

EBITDA takes the EBIT figure one step further and evaluates a company's performance by excluding factors outside of its control, such as depreciation and amortization.

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EBITDA can be calculated by simply adding the reported EBIT on an income statement with the relevant depreciation and amortization entries.

In other words, EBITDA = EBIT + depreciation + amortization.

Like EBIT, EBITDA is used by investors to better evaluate a company's performance without factoring non-cash items such as depreciation and amortization, which are accounting decisions.

Use Caution

At the end of the day, EBIT and EBITDA are valuable measures of a company's performance without factoring in very real costs, such as taxes. As such, a company's reported EBITDA is almost always higher than a company's reported net income.

It is also important to note that EBITDA isn't regulated by generally accepted accounting principles (GAAP), which is a set of standards that is nearly universally adopted by all publicly traded companies. Without a set of industry-wide standards, companies can evaluate internally what they consider to be appropriate inclusions in the EBITDA calculation.