What is EBIT and EBITDA
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What are EBIT and EBITDA? What are the differences between them? And how do we calculate them? • Terms like top line, bottom line, EBIT, GAAP and other terms you may have heard at the office or on an earnings call may make you think that speaking about finance is a completely different language … but have no fear, Acumen Learning is here to help! In this video, we'll define and explain EBIT and EBITDA. • EBITDA is a specific financial metric that helps us understand how we're doing as a company, and stands for earnings before interest, taxes, depreciation, and amortization. • What are depreciation and amortization? Well, whenever we go buy another company or assets, we generally don't expense that investment right away. We don't take the full cost of that investment against our profit right away. Instead, we spread the cost of that asset over the time that we’re going to use the asset to generate revenue, otherwise known as its “useful life”. Basically, depreciation and amortization are the spreading out of large costs over time. • Depreciation is used for tangible assets (ex. furniture and technology equipment, cars, trucks) anything that we can touch and feel. Amortization is used for intangible assets. Things like patents or other intellectual property that we might acquire. One thing to note is that we can’t directly control those expenses. We can influence them by the capital expenditures and acquisitions we make, but it’s not something we manage on a day-to-day basis. • Now that we have defined the DA, let's dive into what is EBIT? EBIT is often called operating income. It's our earnings before interest and taxes. Interest and taxes are considered non-operating expenses; they are costs that don’t impact the core operating success of the company. Operating expenses or “OpEx” include costs that are associated with our core operations, things like costs of goods sold, production costs, and our overhead support functions, and includes the depreciated or amortized costs of asset purchases we’ve made to run our operations. Basically, to calculate EBIT, we start with revenue and subtract costs of goods sold, overhead (otherwise known as selling, general, or administrative expenses) and any other operating expenses such as Research Development that might be related to our core operations. EBIT looks at the profit we earn before we account for non-operating costs, and measures how profitable or “successful” our core operations are. • Ok, so now that we understand the basic definition of these terms, let’s look at how to calculate EBITDA. In short, we find EBIT and then add DA. So, how do we do that? Oftentimes we can find EBIT or Operating Income right on our Income Statement. Then, because depreciation and amortization have already been subtracted to calculate EBIT, we’re actually going to add those back so we can find our profit before those costs. For those familiar with some accounting or financial terms, essentially EBIT is the revenue – cost of goods sold and operating expenses. • You may be asking yourself now, is why do I need to know this. Well, there are two basic reasons why we use EBITDA, and demonstrate why understanding this calculation is critical. One is that EBITDA is the profit that is impacted by you and I based on our day-to-day decisions. Take a look at a Profit Loss (P L) statement. On there, you’ll see a couple of things we can control or impact, like pricing and volume. In other words, our revenue. We can impact our revenue by selling more of the same product, finding ways to differentiate our product to charge more, or even developing new products. Then, we look at costs. Well, we can impact our cost of goods by negotiating prices, finding additional or different suppliers, automating production, and finding cheaper labor — things of that nature. Then we look at our support costs, our overhead. Do we need as much office space? Can we find ways to automate finance or other support processes? Can we speed up hiring and onboarding? And so on. So, EBITDA is used to measure the profit that you and I can control right now. • For financial professionals, EBITDA has another primary use, and that’s projecting profitability and cash flows into the future. Even though it’s not a perfect match, EBITDA is used as a proxy for our future cash flows which are then used to estimate the value of the company. Then, that valuation is used to secure things like debt or additional investments. • As you think about EBITDA, you and I are going to be responsible for making decisions that drive higher EBITDA and higher EBITDA margins. • ✅ Subscribe to our YouTube channel for more videos with business acumen definitions, stories, tips, and tricks! • ✅ Visit our website to learn more about our business acumen training and impacts it has on organizations: https://www.acumenlearning.com/ • #EBIT #EBITDA #Financialexplanation #financialliteracy #finance #businessacumen #financialstrategy
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