When you hear the words EBITDA or EBIT, surely many people will immediately imagine that EBITDA or EBIT is a type of company financial calculation.
This is of course true, considering that EBITDA and EBIT are both indicators for calculating company revenue. However, the difference between EBITDA and EBIT is the way they are calculated.
Get to know EBIT
EBIT stands for Earnings Before Interest and Taxes , or in Indonesian it is known as income before interest and taxes. This EBIT calculation is generally used to measure a company’s operating income.
To calculate EBIT is a task that requires precision, because it needs to be seen from the company’s income statement.
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The EBIT calculation is a calculation that is done by taking the total revenue (all the money the company generates) and then removing all of the company’s operating expenses.
This component includes the cost of goods and production, wages, rent and related overhead and depreciation and amortization.
Another way to get EBIT information is to calculate a company’s net income, then add back interest payments and tax payments. What’s left represents the company’s operating income. In other words, its total revenue minus the costs of staying in business. Note that some analysts will use a different approach called EBT. This is profit before tax.
While used for the same purpose as EBIT, it represents a company’s operating income after accounting for expenses beyond the company’s control.
This analytical approach views interest as an operating expense because companies voluntarily collect it on business trips. This makes it representative of company conduct, valuation and inherent costs.
Usefulness of EBIT Calculation
EBIT calculation is a type of calculation that allows you to view business performance across its core model. In a vacuum where we only consider business operations and nothing else, how financially healthy this company is can be seen from EBIT. Therefore, EBIT is quite an important benchmark.
The value of the EBIT model is that the analyst considers taxes and financing third party expenses. These categories are very important, because no company can stay in business if it can’t pay taxes or make interest payments on debt.
However, if you only consider the company’s net profit, taxes and interest can distort market performance. A very healthy financing or tax environment can make a mismanaged company look good, while a heavy tax burden or a poorly chosen debt scheme can land a solid company in trouble.
For example, consider a healthy company that recently made a heavily leveraged buyback of its own stock. While a company’s after-interest earnings report may show the company is struggling to stay in business, a potential purchaser can look at the EBIT data and see companies with strong fundamentals and a burden of mismanaged debt that needs to be refinanced.
By considering net income only in this operational context, an analyst can understand how well a company is doing its business before capital flows, borrowing structures, and government debt intervene in the results.
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Get to know EBITDA
EBITDA stands for Earnings before interest, taxes, depreciation, and amortization , or in Indonesian it is known as income before interest, taxes, depreciation and amortization. It is a way of measuring a business’s cash flow . To calculate a business’s EBITDA, view a company’s income statement.
In this case, you need to take the total revenue and then factor in all of the company’s operating cash outlays. This includes categories such as the cost of goods and production, salaries and benefits, and rent and overhead.
What is left is a generalized representation of the company’s cash flow in operations. In other words, total revenue minus the money the company is actively spending to stay in business.
Usefulness of EBITDA Calculation
In contrast to EBIT, in calculating EBITDA we do not adjust for depreciation and amortization. This is because neither of the numbers represents the actual cash outlay by the company. They are actuarial representations of lost value as equipment and property age, losses that do not involve the company actually spending the money.
For example, let’s say your company bought a computer one year ago for $1200. Today it may be worth as little as Rp. 800,000. This means that the company is worth Rp. 400,000 less than a year ago, because the total number of properties and holdings have decreased in value, but not actually spent the money.
Using EBITDA allows an analyst to estimate a company’s net cash flow. It provides an indication of the operational health of a company without calculating abstract accounting losses. It also gives analysts a sense of the company’s possible strengths in terms of cash-intensive operations such as expansion, reinvestment, and debt management.
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However, analysts and investors should be careful when using EBITDA. Although cash flow is a valuable metric for a company’s future performance, depreciation and amortization are not hypothetical losses. These components represent true deterioration over time.
Investors who do not properly account for this when they review a company’s performance may be shocked when a company is unable to effectively borrow or convert equity capital into cash, when cash flow is disrupted for large-scale purchases or when performance suffers due to aging equipment.
Main Differences between EBITDA and EBIT
EBIT analysis is a calculation that will tell you how well a company can do its job, meanwhile, EBITDA analysis will estimate what kind of cash spending power a company can have.
EBITDA is especially useful in the case of companies with very large capital investments. In these cases, depreciation and amortization can make a company’s operating budget look much less healthy than it really is, even to the point of showing operating losses despite steady cash flows.
It is important to note, however, that both EBITDA and EBIT are calculations used to reach conclusions and forecast analyses. Neither EBITDA nor EBIT are GAAP approved metrics, and thus are not part of a company’s income statement or cash flow.
In simple terms, EBIT is a calculation that takes into account the estimated amount of revenue a company generates, while EBITDA is a calculation that provides an overview of the company’s overall cash flow.
Each calculation serves a different purpose, but ultimately both are important when analyzing a company’s financial performance.
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Calculation of EBIT or EBITDA for Investment
Before you invest your money in a company, you’ll want to do some research. Both EBITDA and EBIT are indicators of a company’s health. Therefore, either EBITDA or EBIT is an important calculation method for determining investment decisions.
Another useful indicator for evaluating public companies is the debt to equity ratio. This calculation represents the company’s debt (in other words, the company’s liabilities) divided by shareholder equity (the company’s assets and value). A high debt-to-income ratio can indicate a risky investment.
1. How to Calculate EBIT
There are two ways to calculate EBIT. Both ways to calculate EBIT are easy ways. The first method of calculating EBIT is to start with net income and add back the interest expense and taxes paid or reserved:
EBIT = Net profit + interest expense + taxes
EBIT = Sales revenue – COGS – operating expenses
EBIT calculated using the second method is always the same as operating income as defined in GAAP, but EBIT calculated using the first method is different from operating income if net income includes non-operating income and/or expenses.
EBIT is a measure of operating profit. This is true for both calculation methods. By removing the influence of interest and taxes, it demonstrates the underlying profitability of a business regardless of a company’s capital structure or the tax jurisdiction in which it operates.
Business owners and managers can use EBIT is to get an idea of the competitiveness of their business and its attractiveness to investors. Investors and analysts can use EBIT is to compare companies in the same industry sector that have different capital structures or operate in different tax jurisdictions.
However, because EBIT is an indicator that does not include the cost of servicing debt, it can give a misleading impression of a company’s financial viability.
A highly leveraged company may report EBIT is the same value as a company with very little debt, but a highly leveraged company may be more likely to fail if it experiences a sudden drop in sales.
EBIT is one indicator of your company’s financial health. But this indicator, and other financial reports and metrics, rely on accurate and up-to-date data.
Business accounting software helps you accurately report EBIT and other measurements. By utilizing this software, calculating EBIT is an easy process.
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2. How to Calculate EBITDA
There are two widely used methods for calculating EBITDA. The first method starts with net income and adds back interest, taxes, depreciation and amortization:
EBITDA = Net profit + interest expense + taxes + depreciation + amortization
If you calculate EBITDA from a company’s financial statements, you will find net income, interest expense, and taxes on the income statement. Depreciation and amortization are sometimes listed separately as items in the income statement or cash flow statement. Or, they can be aggregated into operating expenses, in which case you can usually find them in the notes that accompany the account.
The second method starts with EBIT, calculated using one of the two methods previously described, and adds back depreciation and amortization. The formula is:
EBITDA = EBIT + depreciation + amortization
The EBITDA calculation removes the basic cost of a company’s assets as well as its financing costs and tax obligations. By removing all non-operating costs, EBITDA provides what some might see as a purer view of the underlying profitability of your business and can provide an indication of its ability to generate free cash from its operations.
EBITDA is especially useful as a measure of profitability in asset-intensive industries where companies are often highly leveraged. For these companies, the annual depreciation/amortization and interest expense associated with the asset can significantly reduce bottom-line profits.
However, because EBITDA excludes these costs, it can give a misleading impression of a company’s financial health. Interest and taxes are real business expenses that drain cash from companies.
And although depreciation and amortization are accounting techniques rather than real cash outlays, many assets actually lose value over time and must eventually be replaced.
Thus, EBITDA can give the impression that a company’s expenses are lower than it really is, and therefore more profitable than it really is.
Why are EBITDA and EBIT Important Indicators?
EBITDA and EBIT calculations are important because EBITDA and EBIT are calculations that determine how well you manage your company, because calculating operational costs such as salaries, rent, and equipment leases are variable costs rather than fixed costs.
You may have little control over direct production costs, such as the cost of the raw materials needed to make a product. However, your management team has a great deal of discretion in areas such as how much you choose to spend on office rent, equipment, and staff.
Therefore, EBITDA and EBIT are indicators that are usually seen as a benchmark of the strength of a company’s superior management team, compared to gross or net profit margins.
Operating profit margins also provide insight into how well your company is performing compared to your competitors, in particular, how efficiently your company manages its expenses to maximize profitability.
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Strategy to Increase EBITDA and EBIT
1. Increase Sales Revenue
First, the strategy to increase EBITDA and EBIT is to increase sales revenue. Sales revenue can be increased by increasing the price you set.
Often market conditions are tight and if competition is tough then you may not have this option. The main method is to create new demand and maintain prices by not giving discounts.
2. Create a New Request
Second, the strategy to increase EBITDA and EBIT is to create new requests. In this case, you can look for ways to package your goods or services or to create new demand through better marketing
3. Evaluate the Actual Discounted Cost
Third, the strategy to increase EBITDA and EBIT is to evaluate the actual discounted costs. There is one bottleneck to sales revenue that is often overlooked, and that is discounts.
Today many businesses are constantly trying to build goodwill and market position, but are rarely successful because customer loyalty is often fleeting. Unless you have a unique product, most buyers are simply going after a comparable good or service from someone who is willing to offer a lower price.
Recognize the dangers of discounting and be wary of crippling your business by selling your time, effort, and products too cheaply. View the latest sales figures and analyze how any promotion, sale or free sample will affect your bottom line. What is the discounted price for you? How can discounts be reduced or eliminated? Frankly assess whether any sales will still be carried out without a discount.
4. Reducing Cost of Goods Sold
Fourth, the strategy is to increase EBITDA and EBIT by lowering the cost of goods sold . If you are serious about reducing the cost of selling your goods, then it can be helpful to assess each expense tactically.
Tips for Accurately Assessing Expenses
The steps that can be taken are to collect data, perform expense analysis, conduct business analysis, cut production costs, develop plans, and execute plans.
Step 1: Collect Data
Compile your most recent financial statements and data using the last three years of information (if possible). Calculations will be easier, faster and more accurate using a financial reporting application for all of your company’s financial activities in a certain period.
Step 2: Analyze Your Spending
Consider how you can manage your internal and external costs. Make a list of your top expenses and examine ways to cut them.
- You can ask the following questions:
- Can staff be moved or rearranged?
- Could the new tool increase efficiency or productivity ?
- Can you get raw materials of similar quality at a lower price?
- Can you get a volume discount on your raw materials?
- Can you renegotiate raw material prices?
Step 3: Analyze Your Business
Look for new strategies by assessing the honest position of your business. A helpful process can be carried out by conducting a SWOT analysis of your business Strengths, Weaknesses, Opportunities and Threats.
Step 4: Cut Your Costs
Determine if there are ways to introduce long-term cost-saving technologies for inventory, production and sales or other ways to increase efficiency.
Step 5: Develop a Plan
Plan a coordinated strategy to reduce costs taking into account what you learned from the SWOT analysis and what can be achieved now and also in the medium and long term.
Step 6: Work the Plan
Unfortunately this is where most great plans fail – they are never fully implemented. Goals and benchmarks have been set, now work on the plan. Schedule a review of your progress and a schedule for each step to be implemented. Monitor progress and continuously adjust your actions.
Seeing the explanation above, it can be concluded that the calculation and management of EBITDA and EBIT is not an easy process. If done manually, calculating EBITDA and EBIT is quite a risky process.