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The what and why Of EBIT And EBITDA - Clare Capital

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The what and why Of EBIT And


EBITDA
November 13, 2013
Business, Tax
Capital, EBIT, EBITDA, Sales, Tax
Mark Clare
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One of the common questions we get asked is why does the term EBIT or EBITDA get used so frequently in
valuation work?
EBIT stands for Earnings Before Interest and Taxes (EBITDA is Earnings Before Interest, Taxes,
Depreciation and Amortisation).
EBIT is sales less expenses (including depreciation) adding back any interest paid and subtracting any
interest received. The only change to EBITDA is that depreciation and amortisation are added back.

Why EBIT or EBITDA? Why not use net profit after tax or some other measure?
In valuation we are trying to determine a reasonable estimate of cash flows and a base level of profitability
for a business that is easily comparable cash flow for discounted cash flow modelling and base profitability

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The what and why Of EBIT And EBITDA - Clare Capital

to complete comparator analysis. EBIT is the corporate finance best estimate for a firms cash flow. EBIT
also strips out the two key differing elements that make figures like net profit after tax hard to compare
between different companies capital structure and tax position. We start with these.
Capital structure describes the mixture of debt and equity that a company uses to finance its operations.
With more debt (also called leverage) on a companys balance sheet the more interest it pays (typically).
The interest cost is included in figures like net profit after tax and can skew comparisons between virtually
identical companies where the only difference is in the amount of debt held by one company.
Different prior earnings histories can also impact figures like net profit after tax. Again assume we have two
identical companies today one that has a history of losses and one that has always been profitable in all
other aspects the companies are identical with the same prospects moving forward. At the net profit after tax
level one company (the one with a history of losses) will have a higher figure than the other as it will have
been able to use its tax losses to off-set current profits and reduce its current tax bill. Again this skews
comparisons so taxes are eliminated from the EBIT figure.
The difference between EBIT and EBITDA is depreciation and amortisation why include or exclude
depreciation and amortisation? In both cases we are trying to estimate a base level of cash flow from the
business. The two key components of calculating this base level of cash flow are the profits that the
business produces and the on-going investments required by the business to achieve these cash flows the
capital expenditure that the company needs to undertake to achieve the profitability. EBIT includes
depreciation and amortisation, which are not cash items, but that act as estimates (imperfect but an
estimate) of capital expenditure. EBITDA removes depreciation and amortisation and thus just focuses on
the profitability of a company without considering the investment required to achieve the profitability.
If you are just using one figure EBIT has advantages. Typically however EBITDA is used more but taking
CAPEX into account.

Glossary

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The what and why Of EBIT And EBITDA - Clare Capital

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