EBIT vs. EBITDA vs. Net Income: How They Differ, and How New Accounting Rules Affect Them

In this tutorial, you’ll learn about the differences between EBIT, EBITDA, and Net Income in terms of calculations, expense deductions, meaning, and usefulness in valuation and company analysis. This tutorial reflects the new accounting rules for Operating Leases that went into effect in 2019.
Resources:
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Table of Contents:
0:00 Introduction
2:15 The Six Main Differences
3:43 Example Calculations for EBIT and EBITDA
7:21 Availability of Money
8:17 OpEx vs. CapEx
9:35 Rent or Operating Lease Expense
11:26 Interest, Taxes, and Non-Core Activities
12:05 Valuation Multiples
13:00 Usefulness of the Metrics
14:46 Operating Lease Details
16:39 The Annoying Interview Question
17:31 Recap and Summary
Lesson Outline:
At a high level, EBIT, EBITDA, and Net Income all measure a company’s “profitability,” but the definition of “profitability” varies a lot, and each metric is calculated differently and represents something different.
EBIT (Earnings Before Interest and Taxes) is a proxy for core, recurring business profitability, before the impact of capital structure and taxes.
EBITDA is a proxy for core, recurring business cash flow from operations, before the impact of capital structure and taxes.
And Net Income represents profit after taxes, the impact of capital structure (interest), AND non-core business activities.
How to Calculate EBIT vs. EBITDA vs. Net Income
EBIT (Earnings Before Interest and Taxes) is Operating Income on the Income Statement, adjusted for non-recurring charges.
EBITDA (Earnings Before Interest, Taxes, and Depreciation & Amortization) is EBIT, plus D&A, always taken from the Cash Flow Statement.
Net Income is just Net Income from Continuing Operations at the very bottom of the Income Statement (“Net Income to Common” or “Net Income to Parent” sometimes).
Availability of Money
EBIT and EBITDA are available to Equity Investors, Debt Investors, Preferred Stock Investors, and the Government.
This is because no one has been “paid” yet! These metrics are both BEFORE Interest Expense, Taxes, etc., since they start with Operating Income on the Income Statement.
Net Income (to Common) is only available to Equity Investors because the Debt Investors received their Interest, and the Government got its Taxes… but the Equity Investors have not yet received their Common Dividends.
OpEx and CapEx
EBIT deducts OpEx and the after-effects of CapEx (Depreciation), but it does not deduct CapEx directly.
EBITDA deducts OpEx, but no CapEx (both the initial amount and the Depreciation afterward are ignored).
Net Income is similar to EBIT: it deducts OpEx and Depreciation, but not CapEx directly.
Rent/Lease Expense
With EBIT under U.S. GAAP, there is a full deduction for Rent. Under IFRS, only the Depreciation element is deducted.
EBITDA under U.S. GAAP is the same: the full Rental Expense is deducted.
But under IFRS, nothing is deducted because both the Interest and Depreciation elements are added back or excluded when calculating EBITDA.
Net Income has a full deduction of the entire Rental Expense under both major accounting systems.
Interest, Taxes, and Non-Core Activities
EBIT completely ignores or “adds back” Interest, Taxes, and Non-Core Business Income. EBITDA is the same.
But Net Income is the opposite - it deducts Interest and Taxes, adds Non-Core Income, and subtracts Non-Core Expenses.
Valuation Multiples
Both EBIT and EBITDA pair with Enterprise Value to create the TEV / EBIT and TEV / EBITDA multiples, respectively.
Net Income pairs with Equity Value to create the P / E, or Price to Earnings, multiple.
What These Metrics Represent
EBIT is often closer to Free Cash Flow (FCF) for a company, defined as Cash Flow from Operations - CapEx, because both EBIT and FCF reflect CapEx in whole or in part (but watch out for Lease issues!).
EBITDA is often closer to Cash Flow from Operations (CFO) because both metrics completely exclude CapEx.
And Net Income is not great for comparisons or for approximating companies’ cash flows. It’s best as a quick and simple metric for quickly assessing a company’s profitability without doing extra work.
EBIT is best for companies highly dependent on CapEx; EBITDA is better for companies that are less so, or if you want to normalize/ignore CapEx and D&A.

[@urbanlegendsandtrivia2023]

Thank you. This is a required video for my American Public University graduate school course.

[@financialmodeling]

Thanks for watching!

[@urbanlegendsandtrivia2023]

@@financialmodeling You're welcome!

[@russellfernandez57]

Thanks, helps me make more sense of what I'm studying :)

[@financialmodeling]

Thanks for watching!

[@WhiteCarBlackWheels]

great video! is it unusual that i look forward to these rare videos once a month or so? i work for a boutique PE and its always interesting to see how your mind works vs how my company does its accounting/valuation.
thanks!

[@financialmodeling]

Thanks for watching. In an ideal world, I would like to publish more often, but my full-time job is creating, updating, and maintaining our courses and guides (which consist of thousands of videos and thousands of pages worth of text). We release free samples from them periodically on this channel.

[@WhiteCarBlackWheels]

@@financialmodeling yeah i definitely get that, have to focus on the stuff that actually makes you $$. the samples are appreciated though, definitely a fun watch. keep up the good work!

[@juanhidalgo6858]

Thanks for this thorough explanation!. Plenty of knowledge pills to look at.

[@financialmodeling]

Thanks for watching!

[@LP-sy3md]

Love all your videos! Thanks for sharing. Will you be interested in making a video on how to evaluate a stock or company for investing purpose? How would you look at the 3 statements on the 10-K? What metrics do you use and how to identify risks? Thanks!

[@financialmodeling]

That topic is too broad for a single, short video, but take a look at the example stock pitches and valuations here for examples.

[@collinsx62]

Great video, thank you.

[@financialmodeling]

Thanks for watching!

[@ecineko1]

amazing videos. Feel blessed. One request: would you please consider doing videos on how to value stocks : from a value investing and from growth investing perspective and across different industries so we can learn the different metrics to look at. These are some ideas for your future videos. Thanks a lot again. You are doing a great service. Keep it up.

[@financialmodeling]

Thanks. We have a bunch of valuation case studies and examples here and even more detailed examples in our courses.

[@didierchampion5443]

Wow! This is some good content here.

[@financialmodeling]

Thanks for watching!

[@gmedia7041]

great video, thanks!
Just one question, one company seems o report depreciation and amortization as an expense and the other isn't, but when you calculate Ebitda you treat both the same, you just add it up to ebit, how is that possible? thanks

[@financialmodeling]

Thanks. Depreciation & Amortization are always Income Statement expenses. The only issue is that some companies show them separately and some embed them within other line items (fully or partially). This is why it's best to add D&A from the Cash Flow Statement - because it's the all-inclusive number. If you start with Operating Income on the Income Statement, you'll always start with a number that has deducted the full D&A expense.

[@thuynportalios2337]

Thanks for making this video. It is very informative. Just one question though. If we follow the definition of EBIT, for example, for each of the years, we can start with Net Earnings, which is Net Income, and then add back Income Tax expense and Interest expense, this will result in a different number for EBIT. EBIT excludes taxes and interest expense but still includes other non-recurring revenue (other revenue earned) if the formula starts with the bottom line. Unless EBIT doesn't take into account other revenue (Gain on sale of investments, investment income and other), then we just need to focus on Operating Income and ignore all the line items below it.

[@financialmodeling]

We do not recommend calculating EBIT like that. It should really just be "Operating Income" on the Income Statement, sometimes with adjustments for non-recurring charges depending on what you're doing. Starting with Net Earnings or Net Income is never ideal unless you have no other way to calculate it.

[@daniwalker1268]

Great insights!

[@financialmodeling]

Thanks for watching!

[@prakasha7706]

Good info

[@yungchiehcheng7774]

Hi Brian,
Are you interested in doing tutorial video about Credit Analysis and Debt Financing Topics?

[@financialmodeling]

There are some tutorials already here on credit analysis and debt. Take a look at: th-cam.com/play/PL5hdd9oiuWS_4yyYBr2bGSo1UbnnpHnDu.html

[@abraaogracco9734]

Very nice, thanks!

[@financialmodeling]

Thanks for watching!

[@georgemelas-kyriazi3304]

Thank you. That was very useful, especially as regards to operating lease accounting and to the ambiguity of ebitda. Amazing that ebitda ignores all operating lease/rental payments under IFRS. One company in which I am invested notes that it reports net income under IFRS and adjusted ebitda under GAAP (or non-GAAP). But I am not sure this is true, because a) lease costs are accounted as dep/amort of ROU assets and interest exp related to lease oblig, and b) ebitda is calculated off of net income and adds back the entire dep/amort (from the CF Statement) and the entire finance expense. I think I need to go back to my Excel sheet and recalculate the ev/ebitda valuation. As you recommended, either add back the lease obligation to the EV (and keep the same ebitda) or not include the lease oblig in the EV, but deduct the lease expenses from the ebitda. Thanks very much.

[@financialmodeling]

I can't really say without seeing the company, but yes, you should probably check and adjust their calculations if required. A lot of companies still don't understand the problems that the new(er) lease accounting rules create.

[@andrebastos3926]

Thanks for the video! Can you give me an example of when does the D&A are important to take into consideration and when it is not? I'm not sure if it is important for industries that require a lot of CAPEX (ex.: gas or airline companies p.e.) or on contrary.

[@financialmodeling]

Depends on what you are trying to do. D&A is more important in industries that depend on physical assets for growth, such as manufacturing. But you might sometimes use EBITDA anyway if you want to "normalize" companies with very different CapEx levels (of course, that also raises questions about the validity of the valuation because capital intensity should matter...). D&A is less important in service-based industries where the growth comes from hiring employees or buying IP (consulting, software, biotech).

[@andrebastos3926]

@@financialmodeling Thank you so much for your answer!

[@JASHVEER22]

Keep up the good work

[@financialmodeling]

Thanks for watching!

[@shaunsusanto9383]

What should i do when the company doesnt show the d&a on the income stAtement? Should i calculate it manually by cfo-net income- nwc or what?

[@financialmodeling]

Search for the terms in the filings. All companies must disclose D&A somewhere. If not, look it up for comparable companies as a % of revenue and apply the average or median D&A % Revenue to your company.

[@shaunsusanto9383]

@@financialmodeling okay thanks

[@user-ff1tv2ie2w]

could you please provide the files you explained in the video.

[@financialmodeling]

Click "Show More" and then scroll to the links in the video description.

[@abhishektul]

Nice

[@financialmodeling]

Thanks for watching!

[@tylermilsop]

Actually had to change playback speed to .75 -- good info but a fast talker.

[@financialmodeling]

Yes, it's difficult because if you show a video to 10 people, 5 will say it's "too slow," and 5 will say it's "too fast." So the best solution is to allow for different playback speeds, as TH-cam does.