EBIT and EBITDA: everything you need to know
If you would like more insight into the actual profitability of your company, then the term EBIT definitely deserves your attention. This abbreviation is often confused with EBITDA, but those two are not quite the same. We will discuss the difference between both extensively in this article. In essence, there are several ways to analyze and also calculate a (potential) company’s profitability. If you are a starting business owner, it would be wise to inform yourself about such things a bit, since this will make it easier for you to decipher whether your future company has any way of surviving amongst the rest of your competitors. In this article, we will discuss EBIT and EBITDA specifically, but you can look up more information about business profitability calculation methods here. Read on for more information about EBIT and EBITDA.
What do EBIT and EBITDA stand for?
EBIT and EBITDA are both abbreviations. EBIT stands for Earnings Before Interest and Taxes, whilst EBITDA stands for Earnings Before Interest and Taxes, Depreciation and Amortization. These methods are sometimes used interchangeably, nonetheless they are different from each other. These methods basically describe how much money you make, before you deduct all that you have to deduct. So essentially; your clean income as an entrepreneur. We will first look at EBIT, and explain its workings, so you understand how to apply these methods.
Detailed information about EBIT
As explained, EBIT is an abbreviation of Earnings Before Interest and Taxes. Earnings are the revenues, Interest is the interest and Taxes are the taxes. So you get Depreciation and Amortization from here (EBITDA). In general, EBIT measures the operational performance of any company, due to the fact that it literally looks at the amount of success you are able to achieve. This also means, that certain forms of financial income for which you don’t have to invest any energy, such as interest, are not taken into account. This is also seen in its name. Taxes come into the picture at a later stage. For now, the only importance is the revenue of your company. It is therefore best to compare the EBIT with the operational operating result. It is used to analyze the performance of a company's core activities without tax costs and the costs of the capital structure that affect profits.
With EBIT, you basically analyze the results of your normal business operations and activities. This is equal to the actual turnover, plus any costs that incurred in order to realize the turnover in the first place. In this case, you can think of costs such as your purchasing costs, the costs for personnel, rent of an office space and all applicable insurances. Any interest payments or interest receipts and taxes are therefore not taken into account. The reason for this is the fact that interest and taxes are not seen as operating results, since they are not directly related to the costs that you have to incur to achieve a certain turnover. So, after you deduct these costs, you get a certain amount which is your EBIT figure. We will explain how to calculate EBIT below.
How to calculate EBIT, and why is it important?
If you want to calculate EBIT, you can use the following formula:
EBIT = total revenue – your cost of goods and/or services sold – your operating expenses
As you can see, this concerns all costs that are seen as operational here. So, why is this figure so important for any business? EBIT is used to analyze the performance of a company's core activities, without the cost of capital structure and tax burden affecting earnings. By omitting these, you can see what your business performance is. The benefit of knowing this figure is that you can put it in your business plan, which will enable investors and other parties in the financial market to evaluate your business performance. Hence,; if you need a loan, knowing this figure can actually aid you in your chances of success. The result of the EBIT is therefore an important figure, since it gives a clear picture of the earning capacity of your company. In this way, it says something about the profitability of a company and expresses this as a percentage. The higher the result in percentage, the more profitable your company is.
What is considered a good EBIT margin?
When you calculate your EBIT margin, you are probably wondering what a good percentage is all about. In practice, the percentage is often used to be able to compare several companies from the same industry as accurately as possible. Meaning; multiple company’s margins are compared to see who is doing well, and which company could use some extra work. It's also good to know that not a single industry is the same. So, the definition of a good EBIT margin can vary per industry. As a result, these are only average guide values, which often form a basis for the profitability of the company that applies to the future. This way you could increase the EBIT margin in all kinds of ways. Ways to do this, for example, are increasing your prices and looking closely at your costs. An EBIT margin between 10 and 15 percent is generally considered a good value. An EBIT margin between 3 and 9 percent is still seen as solid, while a company with an EBIT margin below 3 percent is not seen as very profitable.
The difference between EBIT and EBITDA
Earnings before interest and taxes (EBIT) and earnings before interest, taxes, depreciation and amortization (EBITDA) are very similar methods to calculate a business’ profitability. The main similarity is the fact that both formulas start with your net income, and later add interest and taxes. In addition to EBIT, with EBITDA, depreciation and amortization are also added. The EBITDA method is often preferred, when comparing companies with a large number of fixed assets. Amortization stands for the depreciation through the use of fixed assets, such as the equipment or machines that you need for your business. If you use a machine long enough, it becomes older and at some point will stop working correctly and loses (part of) its original value. Depreciation stands for depreciation due to certain circumstances. For example, if a better machine comes on the market than the one you use now. This will make the machine you own less valuable immediately. Companies with high fixed assets will have higher depreciation, and therefore generally a lower EBIT percentage than companies with fewer fixed assets. This is because the fixed assets are also taken into consideration with EBIT, as opposed to calculating EBITDA.
Detailed information about EBITDA
EBITDA is your profit before deduction of interest, taxes, depreciation and write-offs. Or even more elaborately: the 'result before interest, tax, depreciation of tangible assets and amortization of goodwill'. In summary, you could say: the profit that your company has achieved with its operational activities. So, this is very similar to EBIT at first glance. By calculating your EBITDA, you can get a good overview of the performance of your company, because with EBITDA you show the actual operational performance (or operational profit). It is the result of your normal business operations and activities, meaning: your turnover plus the costs incurred to achieve the turnover. Again, this is the same with EBIT. Revenue represents the amount you get due to sales of products and services. The costs are the amount needed to effect the sale of these products and services. Think of personnel costs, production costs and selling costs.
How to calculate EBITDA, and why is it important?
EBITDA is a measure of the cash flow of your company, in order to meet your interest obligations and to be able to invest. A formula for calculating EBITDA:
EBITDA = Earnings + Interest + Tax + Depreciation + Amortization
Another formula: EBITDA = Operating profit + Depreciation + Amortization
The reason this is also an important margin? Because you learn about your company’s profitability. Of course, you want to know how your company is doing financially, but banks and investors are also interested in those figures. They would like to gain insight into the cash flow of your company, to see whether investing in your company can be seen as fruitful. EBITDA takes into consideration the activities that you carry out in the context of your daily business activities, such as the production and sale of goods and services. EBITDA makes it easier to compare your company to your competitors in the market. EBITDA is therefore also seen as the true future value of a company. And exactly this is what investors look at too. For example, if you have made large investments that help your company to grow further, this will, of course be at the expense of your profit. Since you do not include such costs in EBITDA, as well as interest costs due to, for example, loans, taxes and depreciation on fixed assets, you give a fairer picture of the cash flowing through your company. It’s a realistic formula to show how your company is operating and progressing.
What is considered a good EBITDA margin?
A good EBITDA margin is mostly dependent on the industry. The average EBITDA margin for the in the first quarter of 2021 stood at 15.68%. Therefore, a good EBITDA margin is somewhat the same as a good EBIT margin. To find out if your EBITDA margin is any good, you should consider calculating the profitability of your competitors as well, and compare the figures. Most information required to be able to do this should be found in the published financial data at the website of the Dutch Chamber of Commerce.
Some extra tips to help you along the way
We have accumulated some extra tips and tricks for you to contemplate, related to EBIT(DA) and the cash flow of your company.
- Don't look at EBITDA as an official measuring tool, since it provides no guarantees that you will get a loan, for example.
- Your assets will always lose value over time. Sometimes a company invests a lot of money in the purchase of assets in order to grow quickly. Keep in mind that this means, that you will have to write off enormously later on, or you could be confronted with very high interest costs due to loans. This is why it is good to look at other factors and elements as well.
- Don't confuse EBITDA with EBIT. The two methods are often used interchangeably, but they do differ. EBIT measures the operational performance of a company and shows the result of normal business operations. You do not take into account financial income (interest) or taxes. EBITDA also excludes amortization and depreciation (also known as non-cash).
- An essential indicator remains your cash flow, which is really the blood of your company. Perhaps you want daily insight into that cash flow. As an entrepreneur, you can take all kinds of smart steps for this. Consider, for example, cash flow management. This provides clear and stable insight into a company's ability to have sufficient liquidity, both in the short and the long term. Cash flow management is important for making future strategic choices. A cash flow overview shows you in real time what your available resources are. That way, you know what you can or cannot afford. There is, of course, a lot to consider with a good cash flow overview. You can look into various tools that can assist your company with this, or contact a member of our team for advice on the subject. For a healthy company, it is important that you keep track of your cash flow.
- Map your transactions. This entails your expected income as well as all expenses for your business. No matter how big or small your company is currently, this strategy can help you grow your company and keep it healthy. It will provide you with insight regarding the money that comes in and goes out, which is very important if you want your business to be strong and stable. With such a tool, you can keep a good overview of your liquidity and make safer choices.
Intercompany Solutions can provide you with insight into EBIT and EBITDA
Through knowledge and control of your cash flow, you can actually learn a lot about your own company. Once you know how to calculate your EBIT(DA), you should also be able to make any adjustments whenever necessary. Increasing your EBIT means analyzing where you have slacked and what you can use to improve profitability. An essential metric for everyday business is your cash flow - the lifeblood of your business. Daily insight into that cash flow is a solid way to always be up-to-date. As an entrepreneur, you can take all kinds of smart steps for this: think of cash flow management, for example. This provides insight into a company's ability to have sufficient liquidity in the short and long term. Cash flow management gives you an instrument to make future strategic choices.
Intercompany Solutions is here to help you with that. When you link your bank accounts and accounting systems with specific tools, you always use real-time data. This way, you can always monitor your company's cash flow and easily know how profitable your company can be when making various strategic decisions. If you would like more information about EBIT and EBITDA, then feel free to contact us anytime for helpful advice, or a clear quote for one of the services we offer. Next to providing financial and legal advice, we can also assist you during the entire process of company registration in the Netherlands. We can take care of various practical tasks, as well as advise you about important business decisions.
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