Operating income and EBITDA are two essential metrics that analysts use to assess a company’s operational performance and profitability. Although they both offer insights into a company’s financial health, when it comes to comparing operating income vs. EBITDA, they have different calculations and interpretations. Investors, analysts, and managers should be able to understand the differences between these business metrics.
The key difference between operating income vs. EBITDA is depreciation and amortization. Operating income generally includes these expenses when they are part of operating costs, while EBITDA adds them back, so EBITDA is often higher when depreciation or amortization is present.
What is Operating Income?
Operating income, also called operating profit, measures the profit a company generates from its core business operations before interest and taxes. It is often similar to EBIT, but the two may differ when non-operating income or expenses are included in EBIT.
Operating Income Formula
The formula for operating income is:
Operating Income = Gross Profit − Operating Expenses
Gross Profit = Revenue − Cost of Goods Sold
How to Calculate Operating Income
To calculate operating income, start with revenue, subtract cost of goods sold, and then subtract operating expenses such as selling, general, administrative, depreciation, amortization, and other operating costs. Cost of goods sold typically includes direct production costs such as materials and direct labor.
Operating Income Examples
Consider this operating income example for a hypothetical company with the following financial results:
Revenue: $2,000,000
− Cost of goods sold: $900,000
− Operating expenses: $600,000
Operating income: $500,000
The $600,000 in operating expenses includes $150,000 in depreciation and $50,000 in amortization. Those expenses have therefore already been deducted when calculating operating income.
How to Interpret Operating Income
Operating income is a good indicator of a company’s financial performance in its core business. Positive operating income means the company generated an operating profit during the period after accounting for the costs included in the calculation. Negative or declining operating income can stem from changes in revenue, pricing, volume, cost structure, or operating expenses.
Checking the trend of operating income over time gives us insights into whether the company is improving or declining in its ability to generate profits from its core activities. It’s also a good idea to see how other companies are doing.
What is EBITDA?
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a non-GAAP financial metric often used to evaluate operating performance before financing costs, tax effects, and certain non-cash expenses.
When talking about operating profit vs. EBITDAoperating income vs. EBITDA, both metrics generally exclude interest and income taxes from the operating comparison. EBITDA differs by adding back depreciation and amortization, providing a view of earnings before those non-cash expenses.
EBITDA Formula
The EBITDA formula is:
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
When starting with operating income, the relationship can also be expressed as:
EBITDA = Operating Income + Depreciation + Amortization
How to Calculate EBITDA
- Start with the company’s net income, which can be found on the income statement.
- Add back interest expenses, which can also be found on the income statement.
- Add back income tax expense, which is typically listed in the income statement.
- Add back depreciation expenses, which can be found in the company’s financial statements, specifically in the notes to the financial statements or the cash flow statement.
- Finally, add back amortization expenses, which can also be found in the notes to the financial statements or the cash flow statement.
EBITDA Examples
Using the same hypothetical company from the operating income example above, here is an example of determining EBITDA:
Operating income: $500,000
+ Depreciation: $150,000
+ Amortization: $50,000
EBITDA: $700,000
How to Interpret EBITDA
Understanding EBITDA involves recognizing its significance as a metric that gauges a company’s fundamental operational performance, disregarding specific costs such as interest, taxes, depreciation, and amortization. Higher EBITDA may indicate stronger earnings before financing, taxes, depreciation, and amortization, but it should be evaluated alongside revenue, EBITDA margin, operating income, capital expenditures, working capital needs, and debt obligations.
But it doesn’t take into account things like capital expenditures, changes in working capital, and debt principal payments, so EBITDA should not be treated as the same thing as cash flow.
When to Use Operating Income vs. EBITDA
If you’re looking for a better understanding of a company’s profitability from its core operations, operating income is the way to go. It’s handy for evaluating how well a company’s day-to-day business activities are going and its capacity to make profits, without factoring in non-operational elements such as interest and taxes.
In contrasting operating income vs. EBITDA, EBITDA is commonly used to compare how well companies in the same industry or sector are performing operationally. It takes out the effects of financing choices, taxes, and non-cash expenses such as depreciation and amortization.
Ultimately, deciding between operating income vs. EBITDA comes down to your analysis goals and how much detail you need to evaluate a company’s financial performance.
Operating income may be more useful when you want the cost of depreciation and amortization reflected in operating profitability. EBITDA can be useful for comparisons, valuation discussions, or lender analysis when the goal is to view earnings before those expenses.
FAQS ABOUT OPERATING INCOME AND EBITDA
Is operating income the same as profit?
No. Operating income and profit are different. Operating income represents the profits generated from the main business operations, while profit includes all income and expenses, including non-operating items.
Is 20% EBITDA good?
A 20% EBITDA margin is generally considered good, indicating strong operational profitability. However, what constitutes a “good” EBITDA margin can vary depending on industry standards and specific company circumstances.
Is EBITDA the same as gross profit?
EBITDA is not the same thing as gross profit. Gross profit is revenue minus cost of goods sold, while EBITDA also reflects operating expenses but adds back depreciation and amortization. The two metrics measure profitability at different levels of the income statement.
Is NOI and EBITDA the same thing?
No. There is a difference between EBITDA and Net Operating Income (NOI). Even though both measures evaluate a business’s operational profitability, EBITDA is more often used across industries to evaluate overall performance, whereas NOI is more commonly used in the real estate industry to evaluate a property’s revenue potential.
Where is the EBITDA on an Income Statement?
One of the most frequent questions we’re asked is, “Where is EBITDA on an income statement?” People have trouble finding it because EBITDA is not normally shown on the income statement. Instead, it is calculated using the information from the income statement.
What is adjusted EBITDA?
Adjusted EBITDA starts with EBITDA and removes unusual or nonrecurring items, such as one-time legal costs, restructuring expenses, or gains and losses on asset sales.
It is often used in valuations and sale discussions to estimate sustainable earnings. Because adjustments are not standardized, each one should be clearly supported and documented.
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Janine Smith is a Consulting CFO with TGG. She has a wealth of experience in accounting process development and management, supervising both TGG staff and client’s internal staff (banking, AR, AP, inventory management, payroll), and working with many different types of accounting software. She has worked with clients to develop KPIs that fit their current needs and coached them to support the goals of the business. One of her favorite tasks is budget development and using that as a tool to help organizations meet their goals.