Hey there I'm James you're watching Accounting Stuff and in this video i'll explain what EBIT and
EBITDA both mean how you can calculate them and why they're important
if you're one of my regular viewers then you might have noticed that i'm sat on a different sofa and that's because i've moved
yep i've been living in Vancouver for the last few years but now i'm in Sydney which is actually
where i used to live before i lived in Vancouver that's a fun fact for you
anyways let's jump right in what do EBIT and EBITDA both mean? EBIT and EBITDA are two ways of measuring a business's
profitability they are both acronyms EBIT stands for earnings before interest and taxes and EBITDA
is very similar it stands for earnings before interest, taxes, depreciation and amortization
so where can you find EBIT and EBITDA on financial statements? they both live in the income statement
this is the financial statement which summarizes a businesses revenues and expenses over a period of time
revenue less expenses is profit and like i mentioned EBIT and EBITDA are both
measures of profitability so how can we calculate EBIT? EBIT stands for earnings before
interest and taxes and when we say earnings we mean profit you can find a business's net profit
on the bottom line of income statement so this is going to be our starting point for the calculation
before means that we're going to add back and what are we going to add back?
interest and tax interest expenses are the cost of borrowing money it's a non-operating cost so it sits below
operating profit and tax expenses are what the business reckons it owes to the local tax authority
for this accounting period so we can calculate EBIT earnings before interest
and taxes by taking a business's net profit and adding back the interest and tax expenses this
is our formula and we'll come back to it in the example but how can we calculate EBITDA?
it's a very similar process EBITDA means earnings before interest, taxes, depreciation and
amortization so we start with net profit and add back interest and taxes just like we did for EBIT
but this time we're going to go a step further by adding back depreciation and amortization as well
depreciation expenses are the cost of reducing the book value of tangible assets those are assets
that you can touch this is because of use wear and tear the passing of time or obsolescence and
amortization is very similar it's the cost of reducing the book value of intangible
assets assets that you can't touch so EBITDA earnings before interest, taxes, depreciation and
amortization is equal to a business's net profit plus interest expenses and tax expenses plus any
depreciation and amortization incurred during the year time for an example Firkenflop is a company
that makes sandals which can be paired with woolly socks for a sublime combination of comfort
and style here's their income statement for the year ended 31st of december how do we calculate
Firkenflop's EBIT their earnings before interest and taxes well we know that EBIT is equal to net
profit plus interest expenses and tax expenses during the year Firkenflop made a net profit
of 1.21 million dollars so if we add back their interest expense of 140 thousand dollars and their tax
expense of two hundred and fifty thousand dollars then Firkenflop's EBIT is 1.6 million
dollars simples but hold on a moment there's an easier way 1.6 million dollars is exactly the same
as Firkenflop's operating profit this is no coincidence because EBIT and operating profit are
the same thing most of the time anyway now that we've done and dusted EBIT how can we calculate
Firkenflop's EBITDA their earnings before interest, taxes, depreciation and amortization
EBITDA is equal to net profit plus interest expenses plus tax expenses plus depreciation
plus amortization Firkenflop made a net profit of 1.21 million dollars so we need to add back their
interest expense of 140,000 dollars their tax expense of 250,000 dollars and on top of all of this we add back
their depreciation and amortization of one million dollars that means that Firkenflop has an EBITDA
of 2.6 million dollars given that EBIT and operating profit are almost always the same
a shortcut to working this out would be to say that EBITDA is equal to operating profit plus
depreciation and amortization Firkenflop has an operating profit of 1.6 million dollars so if we
add back their depreciation and amortization incurred for the year of one million dollars
then we can see that their EBITDA is 2.6 million dollars the same as we had before if you find
it hard to remember these equations for EBIT and EBITDA then you can support this channel by buying
my profitability ratios cheat sheet the links in the description but hold up what if you want to
work out EBITDA but you can't find depreciation or amortization in the income statement
this can happen from time to time depreciation might be wrapped up in cost of goods sold if it's
linked to production of inventory if that's the case then there's no need to fret take a peek at
the business's cash flow statement instead if it's been prepared under the indirect method which is
very likely then depreciation and amortization can be found under cash flow from operating activities
they're both added back to net profit since they are non-cash expenses now we know what EBIT
and EBITDA both stand for, what they mean, where to find 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 been influenced by indirect variables that sit outside
of a business's core operations for example interest is the cost of borrowing money which is
determined by a business's capital structure and tax it varies by location maybe we want to compare
companies that are based in two different states or countries if we remove all these interest and
tax expenses then we're left with EBIT which keeps the focus on the business's operating efficiency
EBITDA goes one step further it ignores depreciation and amortization which are the costs
of capital investments if we strip them out as well then you can get a feel for how much profit
the business is able to make doing what it does like selling sandals in the case of Firkenflop
and since depreciation and amortization are both non-cash expenses EBITDA is also a quick way to
estimate if a business can pay its debts when they fall due huge thanks to all my channel members for
supporting Accounting Stuff your contributions are greatly appreciated see you in the next one