EBITDA and EBIT Compared, and What the Letters Leave Out

Earnings before interest, taxes, depreciation and amortisation (EBITDA) is operating profit before depreciation and amortisation are taken off; earnings before interest and taxes (EBIT) is operating profit after them. The only difference between the two is those two non-cash charges. EBITDA is useful for comparing the trading of businesses with different asset ages and accounting choices. Whenever the assets being worn out genuinely have to be replaced, EBITDA misleads. The measure reports as profit money that the machines will demand back.

The confusion starts on the statement itself. Reading down a statement of profit and loss, two profit figures arrive one line apart. The first is bigger and has more letters in its name. The second is smaller and has fewer. Nothing else has happened in between except a single charge. Both figures are ordinary arithmetic on the same twelve months, so the instinct to decide which of the two is the honest one is the wrong shape of question. Honesty does not separate them. One line does.

Before any of the accounting, there is a version anyone can feel. An auto-rickshaw driver counts his day like this: takings, less fuel, less the tea and the cleaning, less the daily charge at the stand. The remainder is what he carries home tonight, and it is a real number. But the auto itself cost him Rs 2,40,000 and it will not see a ninth year. If he sets aside Rs 30,000 every year towards the next one, that set-aside is not a cost he paid to anybody this week and no bill for it ever arrives, yet the day it is needed it will be needed in full. The figure before the set-aside is the EBITDA-shaped figure. The figure after it is the EBIT-shaped figure. Neither one is a lie, and a driver who only ever looks at the first will be surprised in year eight.

Formally, the comparison rests on a single tension. DepreciationThe way the cost of something a business bought and will use for years is spread across those years, so each year carries a share of it as an expense. is an estimate about assets bought in earlier years. Taking it out makes two businesses more comparable, and it also makes any one business look more profitable than it is. Both of those effects are real and they pull in opposite directions. Everything difficult about EBITDA against EBIT comes out of that single tension, and a reader who holds both halves at once will not be fooled by either measure.

The worked case throughout is Anjani Stationers, an invented notebook printer, in its second year: revenue Rs 2,70,00,000, EBITDA Rs 53,50,000, depreciation and amortisation Rs 12,00,000, and EBIT Rs 41,50,000.

What is EBITDA, and what has it already taken off?

EBITDAEarnings before interest, taxes, depreciation and amortisation. A subtotal showing what the trading of a period earned before those four charges are taken off. is earnings before interest, taxes, depreciation and amortisationThe same idea as depreciation, applied to things a business bought that cannot be touched, such as software or a licence: the cost is spread across the years the thing is useful.. The name is not a label sitting on top of a definition. The name is the definition, and it works backwards: everything after the letters E and B is a list of what has been left standing outside the figure. Four charges are named, and only four.

The letters already answer what EBITDA leaves out. The useful question is what it has already taken off, and that is the part readers get wrong. For Anjani Stationers the answer is every cost of trading through the year. Cost of materials consumed of Rs 1,48,50,000, the paper and the board and the ink. Employee cost of Rs 42,00,000. Other operating expenses of Rs 26,00,000, the rent, the power, the freight and everything else the year needed. Revenue of Rs 2,70,00,000 less those three lines leaves Rs 53,50,000, and that is the EBITDA figure. EBITDA is not profit before costs. EBITDA is profit after every cost that was incurred and settled in the ordinary running of the year.

EBITDA is not a figure measured before everything; it is a figure measured before exactly four named charges, and the letters in its name are the list. The list is worth holding on to whenever somebody describes EBITDA as being roughly the cash the business made. EBITDA is not roughly the cash, for three separate reasons that are set out below.

Who decides what goes inside EBITDA?

The business presenting it does, and the choice changes how much weight the figure can carry. The accounting standards set out how revenue and expenses are recognised and how the statement of profit and loss is presented, and they define profit for the period. EBITDA is not among the subtotals they define. EBITDA is a figure a business chooses to show, built by taking the defined lines and stopping short of two of them. The Institute of Chartered Accountants of India issues the accounting standards applying in India, and its text is the place to read which subtotals are prescribed and which are presented voluntarily.

EBIT and EBITDA are both subtotals a preparer presents rather than lines a standard prescribes, so the first thing to check on any EBITDA figure is which costs the preparer decided to put above it. For Anjani Stationers the arithmetic is fixed and visible: Rs 53,50,000 is revenue less the three operating cost lines, with nothing excluded and nothing added back. An EBITDA figure met elsewhere that cannot be rebuilt from the lines above it is somebody's judgement rather than the statement.

What is EBIT, and what does the extra step add?

EBITEarnings before interest and taxes. What the trading of a period earned after every operating cost including the wearing out of assets, and before the cost of borrowing and before tax. is earnings before interest and taxes, and the same trick works: the name states that two charges, and only two, still stand outside it. EBIT is also called operating profitAnother name for the profit a business made from its ordinary trading, before the cost of its borrowing and before tax., and for Anjani Stationers in year two it is Rs 41,50,000.

Getting there from EBITDA takes one step, and the step is Rs 12,00,000 of depreciation and amortisation. The composition of that charge makes the whole comparison concrete. Rs 5,00,000 of it is the delivery van, whose useful life Anjani Stationers revised during year two. The other Rs 7,00,000 is the year's charge on everything else the business bought in earlier years and is still using. One thing is true of the entire Rs 12,00,000: no supplier invoiced it, no bank debited it, and no cheque was written for it during the year. The Rs 12,00,000 is a non-cash chargeAn expense recorded in the accounts for which no money left the business during the period, because the money either left in an earlier period or has not left yet., and the cash it refers to went out years ago when the van and the machines were bought.

The two charges EBIT still stands before are the reason EBIT is used at all, so they are worth naming too. Interest depends on how much the business borrowed, and borrowing is a funding decision rather than a trading one. Tax depends on where the business operates and what reliefs it has. Take both out and what is left describes the operation itself, so two businesses in the same trade can be set against each other on EBIT even when one is heavily borrowed and the other is not.

EBIT is what the trading earned after the wearing out of the assets used to earn it, and before anything to do with how the business is funded or taxed. For Anjani Stationers the whole chain reads Rs 53,50,000, less Rs 12,00,000, gives Rs 41,50,000, less the Rs 3,50,000 finance cost gives Rs 38,00,000 of profit before tax, and less Rs 8,00,000 of tax gives the Rs 30,00,000 that the year finally left behind.

What exactly sits between the two figures?

Depreciation and amortisation, and nothing else. Rs 53,50,000 less Rs 12,00,000 is Rs 41,50,000, the subtraction closes with nothing left over, and there is no third item hiding in the step. Not the finance cost, deducted a rung further down. Not tax, deducted after that. Not one-off items, not write-offs of stock, not anything a preparer chose to describe as unusual.

Two wrong versions of this are common enough to name. The first is that EBIT sits before interest so EBITDA must be before still more interest. The letters say otherwise: both measures are before interest, and the I in EBITDA is doing the same work as the I in EBIT. The second is that EBITDA is a figure before all non-cash items, and it is not. EBITDA is before two specified non-cash charges, and any other non-cash entry in the year, an impairment aside from ordinary depreciation for instance, sits inside EBITDA unless the preparer has separately taken it out and said so.

The whole distance between EBITDA and EBIT is the depreciation and amortisation charge, so given any two of the three numbers the third can always be computed exactly. The rule is genuinely useful arithmetic to carry. A document giving EBITDA of Rs 53,50,000 and EBIT of Rs 41,50,000 and no depreciation figure anywhere has already stated that the charge was Rs 12,00,000.

Why would anyone want a profit figure measured before depreciation?

Because depreciation is the one large expense on the statement that nobody paid this year and that two entirely honest businesses will measure differently. Every other big line has an invoice behind it. Paper was bought at a price, wages were agreed at a rate, the landlord sent a bill. Depreciation has no invoice. Depreciation is the accounts working out how much of an asset bought in an earlier year was used up in this one, and that working rests on two judgements: how long the asset will last, and how its cost should be spread across those years.

Anjani Stationers revised the useful life of its delivery van during year two, and that revision offers the cleanest possible demonstration. Suppose the earlier estimate had been kept and the van's charge for the year had been Rs 3,00,000 instead of Rs 5,00,000. Total depreciation and amortisation would then be Rs 10,00,000 and EBIT would be Rs 43,50,000, a margin of 16.1 per cent instead of 15.4 per cent. Nothing in the business itself would have changed. Not one extra notebook sold. Not one rupee more collected from the Sunrise Public School group. Not one hour of anybody's work. The revision cannot touch a figure measured before depreciation at all, so EBITDA would sit at Rs 53,50,000 either way.

EBITDA exists because depreciation is the line most affected by judgements made about earlier years, so stripping it out is the quickest way to compare what two businesses are doing right now. Comparison across asset ages is the honest case for the measure, and it is a good one. A business running eight-year-old machines that are nearly written down will show a small depreciation charge and a flattering EBIT; the identical business that bought its machines last year will show a large charge and a poor one. On EBITDA the two are on the same footing.

Where does EBITDA mislead, and where is it fair?

EBITDA misleads the moment its answer is treated as money the business is free to keep. Depreciation is the accounts' estimate of assets being used up, and for most businesses being used up is not a metaphor. The van will need replacing. The cutting machine will need replacing. The money for that comes out of the same trading the EBITDA figure is describing, so the assets have a prior claim on part of it. The prior claim is why practitioners talk about maintenance capexThe spending a business has to keep making on its existing assets simply to carry on operating at the same level, as distinct from spending that expands what it can do.. Maintenance capex is the spending needed just to stand still, and treating EBITDA as a proxyA stand-in figure used because it is easier to get than the thing actually being measured, and reliable only where the two move together. for cash works only in businesses where that spending is genuinely small.

There are two further reasons EBITDA is not cash, and they are worth naming so nobody has to discover them the hard way. Interest and tax are both real payments and both sit below EBITDA. And money tied up in stock and in unpaid customer bills never appears in either measure, so a business can grow its EBITDA while its bank balance falls. The bridge from a profit figure to actual cash is covered under the cash flow statement.

The second failure is subtler and catches careful readers. The same removal that makes EBITDA fair across asset ages makes it unfair between a business that rents its equipment and one that has bought it. Picture two wedding caterers of the same size, each invented. Ratna Caterers rents its utensils and burners for Rs 2,00,000 a year, and that rent is an operating expense, so it sits above EBITDA. Vaidya Caterers bought the same equipment outright some years ago and pays no rent. Instead it carries Rs 2,00,000 of depreciation, and depreciation sits below EBITDA. Same trade, same scale, same cost of having equipment. On EBIT they both earn Rs 4,00,000. On EBITDA one earns Rs 4,00,000 and the other Rs 6,00,000, a full half more, purely because of how the equipment was obtained.

EBITDA is fair when the question is what the trading did this year, and misleading the moment the figure is read as money the business gets to keep, so the measure is a tool for comparison rather than a measure of what was earned. Both of the caterers' EBITDA figures are correctly computed, and neither says which business is better run.

Now hold the harder version of the same idea, the one that costs money rather than marks. Take Anjani Stationers' Rs 53,50,000 of EBITDA and set beside it an invented twin, Devgiri Printing Works, a press-heavy printing works with exactly the same Rs 53,50,000 of EBITDA on exactly the same Rs 2,70,00,000 of revenue, and Rs 34,00,000 of depreciation because presses cost far more than notebook-binding tables and wear out on a schedule of their own. The difference in depreciation is what capital intensityHow much a business has to have tied up in machines, buildings and equipment to produce a given amount of sales. A high figure means a lot of assets standing behind each rupee of revenue. means in practice. At EBIT, what happens to the two businesses?

What does the gap look like when it is written out?

Two ways of sizing the gap are worth having, and readers mix them up constantly. The first is the gap as a share of EBITDA: Rs 12,00,000 over Rs 53,50,000 is 22.4 per cent for Anjani Stationers, and Rs 34,00,000 over the same EBITDA is 63.6 per cent for Devgiri Printing. The second is the gap in margin points: Rs 12,00,000 over revenue of Rs 2,70,00,000 is 4.4 points, exactly the distance between the 19.8 per cent EBITDA margin and the 15.4 per cent EBIT margin. Both are correct and they answer different questions. The share of EBITDA gives how much of the reported trading figure the assets have a claim on. The margin points give how much of each rupee of sales the assets take.

Sit with the last two rows. Anjani Stationers keeps a little over three quarters of its EBITDA once the wearing out of its assets is counted. Devgiri Printing keeps just over a third. Identical EBITDA of Rs 53,50,000 becomes Rs 41,50,000 and Rs 19,50,000 at EBIT, and the difference between those two outcomes was decided entirely by how much equipment each business needs to do its work. A reader who only ever looks at the first measure will never see that difference, and it is not a small one.

The pattern runs across trades rather than being a quirk of one pair. Set five invented businesses side by side, each given the same Rs 53,50,000 of EBITDA so that only the depreciation differs, and the gap widens steadily as the work gets heavier: a design studio that needs little more than desks, a notebook printer, a courier operation running its own vans, a printing works, and a paper mill.

Six settings of the depreciation charge show the same movement written out. At no depreciation at all, both measures read Rs 53,50,000 and both margins 19.8 per cent, and neither measure flatters. At Rs 6,00,000, EBIT is Rs 47,50,000 at a margin of 17.6 per cent, and the gap is 11.2 per cent of EBITDA. At Rs 12,00,000, the charge Anjani Stationers reported, EBIT is Rs 41,50,000 at 15.4 per cent and the gap is 22.4 per cent. At Rs 22,00,000, EBIT is Rs 31,50,000 at 11.7 per cent and the gap is 41.1 per cent. At Rs 34,00,000, Devgiri Printing's charge, EBIT is Rs 19,50,000 at 7.2 per cent and the gap is 63.6 per cent. And at the top of the slider, Rs 40,00,000, EBIT is Rs 13,50,000 at 5.0 per cent while the gap is 74.8 per cent of the EBITDA figure, so three rupees in every four of the reported trading are owed to the assets.

What do a lender and an analyst actually do with these two?

Neither of them chooses. A practitioner computes both and then reads the distance between them as the number that carries the information. Understanding the pair means understanding that distance. Memorising the two definitions does not.

The lender is the most likely of all readers to be caught. Anjani Stationers' finance cost for the year is Rs 3,50,000. Covering that on EBITDA gives Rs 53,50,000 over Rs 3,50,000, or 15.3 times. Covering it on EBIT gives Rs 41,50,000 over Rs 3,50,000, or 11.9 times. Same borrower, same loan, same twelve months, and 3.4 times of apparent headroom appears or disappears depending only on which measure the test was written against. Tests of the same shape are commonly written on EBITDA, including the familiar comparison of borrowing to EBITDA. How much a business has borrowed is covered under the balance sheet. A careful lender then asks the separate question that EBITDA cannot answer: what has to be spent on the existing machines each year for this business to keep trading at all. For a notebook printer that may be modest. For Devgiri Printing it is the whole argument.

The analyst's habit is narrower and easy to copy. Compute both margins, every time, and write the basis beside each one. A margin of 19.8 per cent and a margin of 15.4 per cent are the same business, and an unlabelled margin helps nobody. Then track the gap as a share of EBITDA across years. If that share jumps without new machines arriving, an estimate has probably changed, exactly as happened with the van at Anjani Stationers. If it jumps because new machines did arrive, the business has become more capital intensive and its EBITDA has become a worse guide than it was.

The person buying a small business does the plainest version of all, and it is the auto driver's question again. Ask what the trading earns, then ask what the equipment will cost to replace and when. A practitioner does not pick between EBITDA and EBIT; both are computed, and the distance between them is read as the size of the claim the assets have on the trading.

Which measure answers which question?

The pairing holds beside any statement of profit and loss. Each question a reader arrives with has one measure that answers it, and the year-two figure for Anjani Stationers beside each shows the shape of the answer rather than the abstraction.

Two habits make the table stick. The first is to quote the pair rather than the figure: saying EBITDA of Rs 53,50,000 and EBIT of Rs 41,50,000 takes four extra words and removes the entire ambiguity. The second is to say the gap out loud as a share of EBITDA before using either number for anything. A gap of 22.4 per cent and a gap of 63.6 per cent are different worlds, and the EBITDA figure is identical in both. EBITDA answers a comparison of trading and EBIT answers what was earned, and where the question itself is unclear, both are computed and the pair quoted.

Anjani Stationers Private Limited, Devgiri Printing Works, Ratna Caterers, Vaidya Caterers, the Sunrise Public School group and the unnamed trades set beside them are invented.
Educational material. Not advice on any investment, tax, budget or market position.