Value of firm formula using EBIT

Table of Contents:

• 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

Interview questions about EBIT vs EBITDA vs Net Income are some of the most common ones in investment banking interviews.

Some of the most common interview questions related to these metrics include:

“Is EBIT or EBITDA better? What about Net Income? How are they different?

Which one(s) should you use in valuation multiples when analyzing companies?”

At a high level, EBIT, EBITDA, and Net Income all measure a company’s profitability, but the definition of “profitability” varies a lot.

EBIT (Earnings Before Interest and Taxes) is a proxy for core, recurring business profitability, before the impact of capital structure and taxes.

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) 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.

So, they all represent profitability or cash flow in some way, but their exact calculations and meaning differ quite a bit.

EBIT vs EBITDA vs Net Income: The 6 Key Differences

We’d summarize the key differences between these metrics as follows:

1. To Whom is the Money Available? – Equity Investors? Debt Investors? The Government? All three? Just one?
2. Operating Expenses (OpEx) vs. Capital Expenditures (CapEx) – Some metrics deduct both, some deduct neither, and some deduct one, or part of one.
3. Rent/Lease Expense – Some metrics deduct the full lease expense; others deduct only part of it, and U.S. GAAP vs. IFRS creates complications (accounting changed in 2019!).
4. Interest, Taxes, and Non-Core Business Activities – Some metrics deduct (or add) all of these, while others ignore them.
5. Valuation Multiples – Some metrics pair with Enterprise Value (TEV), while others pair with Equity Value (Eq Val).
6. Usefulness – Sometimes, you want to reflect CapEx, and sometimes you want to ignore it or “normalize” it.

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).

Here are example calculations for EBIT vs EBITDA for Target and Best Buy:

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.

So, EBIT and Net Income are more useful if you want to reflect the company’s capital spending.

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.

If you’re comparing U.S. and non-U.S. companies, you should use EBITDAR to normalize and make a proper comparison:

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.

This difference is one big reason why Net Income is not so useful when comparing different companies – there are too many differences due to capital structure, side businesses, tax treatments, and so on.

Valuation Multiples

Both EBIT and EBITDA pair with Enterprise Value to create the TEV / EBIT and TEV / EBITDA valuation multiples, respectively.

You do have to be careful with Lease-related issues, and EBIT, as traditionally calculated, is no longer valid under IFRS for use in the TEV / EBIT multiple.

Net Income pairs with Equity Value to create the P / E, or Price to Earnings, multiple.

The test is simple: if the metric deducts Interest Expense, pair it with Equity Value. If it does not, pair it with Enterprise Value.

For more, see our detailed guide to Enterprise Value vs. Equity Value.

Here’s a comparison table for these valuation multiples, using representative numbers from an airline company:

What EBIT vs EBITDA vs Net Income 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.

You can see this in the calculations above for Target and Best Buy:

For both companies, EBIT / FCF is around 100%, and EBITDA / Cash Flow from Operations is around 100%.

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.

Operating Lease Details

In 2019, the accounting rules changed, and Operating Leases moved onto companies’ Balance Sheets, so you will see both Operating Lease Assets and Operating Lease Liabilities there (for more, see our full tutorial to lease accounting).

But the problem is that Rent is still Rent under U.S. GAAP, but under IFRS, it’s split into “fake” Depreciation and Interest elements.

The company still pays the same amount of Rent, but it has to split it up artificially into Interest and Depreciation.

So, you must be careful to deduct either the entire Rental Expense, or none of it, in these metrics.

If you deduct the entire Rental Expense, do not add Operating Leases to Enterprise Value; vice versa if you exclude or add back the entire Rental Expense.

For example, with EBIT and EBITDA under U.S. GAAP, you should not add Operating Leases to TEV because both of these deduct the full Rental Expense.

But with EBITDA under IFRS, you should add Operating Leases to TEV because EBITDA excludes the full Rental Expense in that system.

This quick comparison table sums up the differences with Operating Leases:

EBIT vs EBITDA vs Net Income: Which Valuation Metric is Best?

This is a stupid question because it assumes that there is a “best” metric.

When valuing companies, you always look at a range of metrics: Revenue, EBIT, EBITDA, Net Income, FCF, etc.

Each one tells you something different, which is why you want to look at more than one – to get the full picture.

With the EBIT vs. EBITDA choice, it depends on how you want to treat CapEx.

To completely ignore it, use EBITDA.

To factor it in, partially, use EBIT. Also, remember that EBIT isn’t valid in valuation multiples under IFRS, so you have to rely more on EBITDA and EBITDAR there.

EBIT vs EBITDA vs Net Income: Final Thoughts

Here’s a comparison table that shows all these differences for these metrics:

Video Transcript

Welcome to another tutorial video. We’re going to go over the concept of EBIT, earnings before interest and taxes, versus EBITDA, earnings before interest, taxes, depreciation, and amortization, versus net income in this lesson. These concepts often come up in somewhat confusing and arbitrary interview questions, and so we’re going to go over all the differences between these metrics and how you use and calculate them differently. Now, if you’re paying close attention, you’ll notice that we have covered this topic before. In fact, it was one of the earliest videos in this entire channel, but I was never happy with the original presentation and some of the examples, and I felt they were a bit unclear.

Also, more importantly, some accounting rules have changed since that video is first published, so this one needed an update and we need to go over some of the new rules that have impacted how you calculate EBIT and EBITDA especially. The most common interview questions on this topic goes something like this, “Is EBIT or EBITDA better? What about net income? How are they different? Which one or ones should use in valuation multiples when you analyze companies?”

Let’s look at the short answer first at a high level before getting into the details. All these metrics, EBIT, EBITDA and net income measure a company’s profitability in some way. However, the definition of profitability and the specifics of the calculations are quite different. EBIT, earnings before interest and taxes, is a proxy for core, recurring business profitability before the impact of capital structure and taxes. EBITDA, earnings before interest, taxes, depreciation and amortization is a proxy for core, recurring business cash flow from operations before the impact of capital structure and taxes, so these two metrics differ based on profitability versus cash flow from operations.

Then, net income is profit after taxes, the impact of capital structure, and non-core business activities, so it includes and deducts a whole lot more items than either EBIT or EBITDA. Now, in terms of the other differences between these metrics, we can separate them into six main categories. First, there is, “To whom the money is available? Is it available to just the equity investors, in other words, the common shareholders, to the debt and investors, to the government, to all three, or maybe to just one or two of these groups?” Second is the treatment of operating expenses, OpEx and capital expenditures, CapEx, because some of these metrics deduct both of these.

Some deduct neither one and some deduct one or part of one, but not the entire thing. Then, there is the rent or lease expense associated with operating leases. Some of these metrics deduct the full lease expense, others deduct only part of it, and U.S. GAAP versus IFRS, the accounting system the company uses, creates complications as well because the accounting rules changed in 2019. Take a look at our video on operating leases and how the accounting rules for that changed for more on this topic. We’ll deal with it a little bit in this video, but there is a dedicated tutorial on this topic as well. The fourth way in which they differ is with interest, taxes and non-core business activities.

Some metrics deduct or add all of these, and then others completely ignore them. With valuation multiples, some metrics pair with enterprise value, also known as TEV, and then others pair with equity value, which we’re just abbreviating to Eq Val in this tutorial. Then finally, the last point here, usefulness. Sometimes you want to reflect CapEx, and sometimes you want to ignore it or normalize it. This question of, “Which valuation metric or multiple is best?,” really goes back to what you’re trying to accomplish, and you’ll see that as we go through these examples.

With that said, let’s now start and go first into the calculations here and look at how you calculate EBIT, EBITDA, and net income using a few real companies as examples. EBIT stands for earnings before interest and taxes, and this one is just operating income on the company’s income statement adjusted for non-recurring charges. EBITDA, which is earnings before interest, taxes and depreciation and amortization is just EBIT plus D&A, depreciation and amortization, which should always be taken from the cash flow statement. Then, net income is just net income at the very bottom of the income statement. Companies often list multiple types of net income.

You want the one that is net income to common, or called net income to parent, whatever has subtracted as much as possible, except for items like discontinued operations. Let’s take a look at two examples here for Target and Best Buy. These are both fairly standard companies following U.S. GAAP, and see how we calculate these metrics. I have up here on screen Best Buy’s financial statements. We would start the EBIT calculation with operating income on the income statement, and to save some time, I’ve already filled this in.

You can see operating income from the income statement right here. The only question we need to ask ourselves here is, “Do we add back anything for the non-recurring charges here?” We see the company does have restructuring charges listed on its income statement, but these are not really non-recurring because they happen in three out of three of the past three years. Clearly, the company’s constantly restructuring, so in our opinion, this is not a non-recurring charge, and so we’re not going to add this back. Now, moving to the cash flow statement, they still have the same restructuring charges, but nothing else here really counts or stands out as a non-recurring item, so we’re just going to stop here for Best Buy and just say there are no non-recurring charges, and just add these up as is.

Now, to get to EBITDA next, we always want to get depreciation amortization from the cash flow statement. Often, it’s not even listed as a separate item on the income statement because it’s embedded in these others, and even if it is listed, it may not be the full amount, so we want to get it from the cash flow statement down here, and that is exactly what I’ve done. I’ve already filled in the numbers, and we can do this and add up our EBITDA for Best Buy right here. Let’s go over for Target and see how it works here. Once again, we want to start with operating income, and so to save some time, I’ve already filled this in in Excel, operating income from the income statement.

Once again, we need to look at the company’s possible non-recurring charges. We don’t really see anything above the operating income line that counts as non-recurring on the income statement. If you go to the cash list statement down a little bit, we see some typical line items here, non-cash losses and gains, loss on debt extinguishment. The issue with these items is that these usually do not affect the operating income. These are typically shown within other income or expense right below the operating income line, so it doesn’t make sense to add these back, and nothing else here really counts so we’re not going to use anything here.

We’re just going to note that we want to take depreciation and amortization from the cash flow statement, in this case. If you look at the income statement numbers for this company, it’s actually different because they are including depreciation and amortization partially within cost of sales or cost of goods sold. The bottom line though, for Target is that we don’t see anything that qualifies as an obvious non-recurring charge, so we will just take operating income as is, and then for EBITDA, we’ll take EBIT and add our D&A from the cash flow statement, and we have that. We didn’t even look at net income are listed here, but if you wanted to do that, you would simply go to the income statement and get something like net earnings from continuing operations here for Best Buy, and for Target, similar idea, net earnings from continuing operations. That’s a bit about how to calculate these metrics.

Let’s now go to the first major way in which they’re different, which is the availability of the money. EBIT and EBITDA are available to equity investors, debt investors, preferred stock investors, and the government, and this is because no one has been paid yet. These metrics are both before interest expense and taxes because they start with operating income, and you can see that very clearly if you look at the company’s financial statements. We have operating income. None of those parties has been paid yet, and then we have interest expense, so the lenders get paid, then we have the income tax expense, so the government gets paid.

Now, they’re out of the picture, and the net earnings here are only available to the common shareholders. We always get questions about principal repayments of debt, which show up on the cash flow statement, and the short answer is that these don’t count as the lenders, the debt investors getting paid because these are just paybacks of the initial amount. It’s not as if they’re earning something on top of whatever they lent the company from these principal repayments. Let’s go to the second major distinction here, which is OpEx versus CapEx. For this one, I’m going to pull up target statements because I think it’s a bit easier to see the principles on this one here.

EBIT deducts operating expenses and the after-effects of CapEx. In other words, depreciation, but it doesn’t deduct CapEx directly. If you look at Target’s statements, you can see very clearly that they’re deducting depreciation and amortization partially here, partially within cost of sales to get to operating income. Since that it happens, we say that it partially reflects CapEx because this D&A is coming from CapEx, the company spent in previous years, and maybe this year as well. EBITDA deducts OpEx, but it does not deduct CapEx at all.

It completely ignores the initial amount, and also the depreciation afterward for pretty obvious reasons that we are literally adding back the entire amount right here, so we’re completely ignoring it in this metric. Then, net income is very similar to EBIT, and that it deducts OpEx and depreciation, but it doesn’t deduct CapEx directly. Again, you can see it by looking at Target’s statements. We have this deduction for depreciation and amortization, and we have the standard operating expenses, and all of these are deducted ultimately to get to the net income number. The bottom line is that EBIT and net income are more useful if you want to reflect a company’s capital spending and capital expenditures.

Then, there’s the issue of the rent or operating lease expense. This one is a little harder to illustrate because most companies don’t show this explicitly in their statements, but EBIT, under U.S. GAAP has a full deduction for rent, because under U.S. GAAP, the rental expense is shown as a part of selling general and administrative expenses, and it’s just a standard operating expense. Under IFRS, however, it is split into depreciation and interest elements. I have more on this in the leases tab of the Excel file that goes along with this lesson. The bottom line is that under IFRS, a $35 lease expense is split into 25 of depreciation and 10 of interest, for example.

Now, in reality, this is not really interesting depreciation. The company still pays the same amount in rent, but it’s just split up differently. Under U.S. GAAP, it’s the same as always, and we still see that $35 operating lease expense under operating expenses on the income statement. With EBITDA, there’s a full deduction for rent under U.S. GAAP, because again, it’s just a perfectly normal operating expense right here, but under IFRS, nothing is deducted because EBITDA adds back both interest and depreciation, meaning that it’s going to add back the interest component of operating leases here, and also the depreciation component associated with these leases. Then, with net income, there’s a full deduction of the entire rental expense under both major accounting systems.

The bottom line is that leases do get very tricky, and if you’re comparing U.S. and non-U.S. companies, you have to be careful because the accounting differs, and honestly, in these cases, you should probably just use a metric like EBITDAR to normalize. For your reference, I have it down here at the bottom. EBITDAR is essentially just EBITDA, plus the rental expense, and it ensures that no matter what accounting system you’re using, this completely excludes or adds back the full lease expense, and that makes it better for comparing companies using different accounting systems. Let’s go to the fourth topic now, interest taxes and non-core activities. EBIT completely ignores or adds back interests, taxes and non-core business income, and EBITDA, it’s pretty much the same, and you can see that pretty easily by looking at the statements.

Everything non-core or relating to interest and taxes is shown below the operating income line, therefore, it cannot possibly deduct them. On the other hand, net income is the opposite. It deducts everything, interests, taxes, non-core expenses, and it adds non-core business income. This is one reason why net income is not that useful when you’re comparing different companies. There are just too many differences because of capital structure, side businesses, different tax treatments, and so on and so forth.

With valuation multiples, EBIT and EBITDA both pair with enterprise value. Why? Because enterprise value represents all investors in the company and EBIT and EBITDA, as you learned previously in this tutorial, could potentially go to the equity investors, the debt investors, preferred stock investors, and the government because they exclude preferred dividends, interest expense, taxes, and so on. You have to be careful because there are some lease issues here once again, which you’ll see if you pull up the Excel file linked to below this video, but this is the basic idea. Now, net income pairs with equity value because net income is only available to the equity investors. Equity value represents the equity investor or common shareholders, and you take equity value divided by net income to create the PE or price-to-earnings multiple.

The test here is pretty simple. If the metric deducts interest expense, you pair it with equity value. If it does not deduct interest expense or it adds it back, then you pair it with enterprise value. Then finally, the last point here, the usefulness of these metrics. EBIT is often closer to free cash flow for a company, which is defined as cash flow from operations minus CapEx, because both EBIT and free cash flow reflect CapEx either 100% of it or part of the CapEx due to the depreciation. There are some lease issues once again, but this is the basic idea. EBITDA is often closer to cash flow from operations because both metrics completely exclude CapEx. To see this one in action, let’s go back to our Excel file and let’s look at EBITDA compared to cash flow from operations for Best Buy and Target, and then do the same thing for EBIT and free cash flow.

Then, EBIT divided by free cash flow, and let’s actually calculate our free cash flow while we’re at it, and then let’s just copy these across, and you can see that it’s not a perfect match. It’s not exactly 100%, but it’s pretty close. We’re around 100% to around 120, 125% for both these metrics, and Target is actually even closer. It is 96%, ranging up to a very high number of one year, but usually in that 95 to 110 or 115% range, so this rule works fairly well for these companies. Net income isn’t really great for comparisons, and it’s also not great for approximating companies’ cash flows.

It’s best used as a very quick and simple metric you can use to quickly evaluate companies if you don’t have anything else. EBIT tends to be best for companies that are highly dependent on CapEx, capital expenditures, EBITDA is better for companies that are not as dependent on them, or if you want to ignore or normalize CapEx and D&A between different types of companies. I’ve been mentioning these annoying lease issues throughout, so here’s a quick summary of those as well. In 2019, the accounting rules changed, and operating leases moved onto companies balance sheets directly, so you now see an operating lease asset or a right of use asset on the asset side of the balance sheet, and on the other side, you see operating lease liabilities. The problem though, is that rent still counts as rent under U.S. GAAP. It shows up as a normal operating expense on the income statement, but under IFRS, it’s split into depreciation and interest, even though these are really fake depreciation and interest because the company still pays the same amount in rent, so you have to be really careful to deduct either the entire rental expense or none of the rental expense when you create these metrics, and if you deduct the entire rental expense, you can’t add operating leases to enterprise value.

If you ignore the entire rental expense or add it back, then you do want to add operating leases to enterprise value, and if you go to the leases tab over here in this file, you can see that under U.S. GAAP, it’s still fine to not count operating leases as debt, and then to use the traditional EBIT and EBITDA, and enterprise value to EBIT, and enterprise value to EBITDA, but if we count operating leases as debt, then EBIT and EBITDA no longer makes sense. 

Instead, we have to use EBITDAR and we have to add operating leases in this enterprise value calculation. Under IFRS, what this means is that EBIT by itself is no longer really a valid metric because it deducts only part of the rental expense. Instead, we have to rely on EBITDA or EBITDAR, which both completely exclude the full rental expense under IFRS, and then use enterprise value divided by EBITDA, enterprise value divided by EBITDAR, and in both cases, make sure that our numbers here include operating leases as part of the enterprise value calculation. In terms of the annoying interview questions here, the most ridiculous one is, “Which metric is best?”

It’s a stupid question because it assumes there is a best metric, and there really isn’t. When you value companies, you always look at a range of metrics, revenue, EBIT, EBITDA, net income, free cash flow and so on. Each one tells you something different, which is why you want to look at more than one. You always want to get the full picture of the company’s performance. With this question of EBIT versus EBITDA, it depends on what you want to do with CapEx.

If you want to completely ignore it, then EBITDA is your best metric. If you want to partially factor it in or it’s important for the company’s industry, then EBIT may be a better metric. Also keep in mind that EBIT, as traditionally calculated, doesn’t work under IFRS, so you pretty much have to use EBITDA or EBITDAR there, and that’s just because of the interest and depreciation split with the rental expense once again. We’re at the end, so let’s do a recap and summary. In this case, I actually have the comparison table in Excel, which, again, I’ve linked to below this video, which you can look at, but to look at the pasted in version here, we went over the calculation differences.

You’re starting with operating income and adjusting for non-recurring charges. For EBITDA, you also add D&A from the cash flow statement. For EBITDA, you also add the rent or lease expense on the income statement, and then net income is just the very bottom most net income from continuing operations on the income statement. EBIT and EBITDA and EBITDAR pair with enterprise value, but you may add or not add operating leases depending on what you’re doing. Net income pairs with equity value.

There are a bunch of differences related to leases under U.S. GAAP versus IFRS, and you just have to be careful that you are either deducting the full rental expense or excluding the full rental expense in the denominator, and then doing the appropriate thing in the numerator, either adding operating leases to enterprise value or completely ignoring them, and not adding them. In terms of who has a claim on the money, for the first three, EBIT, EBITDA and EBITDAR, it’s equity investors, debt investors and the government. For the last one, net income, it’s just equity investors. EBIT is a proxy for core recurring business profitability before the impact of capital structure and taxes. EBITDA is more about business cash flow from operations before capital structure and taxes.

EBITDAR is similar, but it also ignores leases, and then net income is profit after taxes, the impact of capital structure, and non-core business activities. All these metrics deduct normal operating expenses, but the treatment of the rent or lease expense varies widely, depending on which one you’re looking at. With CapEx, EBIDA and EBIDAR completely ignore it. Net income and EBIT partially factored in because they both deduct depreciation. Most of these metrics ignore taxes and interest, income and expense, and non-core business activities, except for net income, which actually deducts or adds all of these.

EBIT is a proxy for free cash flow, in many cases. EBITDA is a proxy for cash flow from operations, and net income and EBITDAR aren’t really a proxy for much of anything. EBIT is better when CapEx is more important or you want to include the impact of CapEx. EBITDA is better when you do not want to do that, when you want to ignore it or when CapEx is less important. EBITDAR is best when you’re trying to normalize different lease treatments because of different accounting systems, and net income really isn’t useful for the much of anything, but it can be good as a very quick metric to look at if you’re just trying to get a quick read of a company’s performance.

That’s it for this lesson on EBIT versus EBITDA versus net income. Hopefully now, you understand some of these differences, you have some good examples in Excel to go back to, and you have this comparison table as you prepare for interviews, case studies, and the job itself.

How do you calculate the value of a firm using EBIT?

How do you calculate the value of a firm?

How do you value a company using EBITDA multiple?

Is enterprise value the same as EBIT?