Earnings Vs. EBITDA

If you're looking at financial figures for a company, you might see a lot of terms that all refer to some measure of money coming into a company. Two common ones are earnings, usually meaning overall profit or loss, and EBITDA, which is earnings before interest, taxes, depreciation and amortization. Whether it's more important to look at EBITDA vs. revenue or some other metric may vary based on your investment priorities and appetite for risk.

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Earnings refers to the amount of income (or loss) a company saw in a particular period of time, usually a quarter or a full year. EBITDA stands for earnings before interest, taxes, depreciation and amortization, and it adds those costs back into a company's bottom line before counting earnings.

Understanding Corporate Financial Statements

Publicly traded companies in the United States typically must file quarterly and annual reports with the Securities and Exchange Commission. These reports include financial statements, which usually must include metrics that are in compliance with what are called generally accepted accounting principles, or GAAP standards.

The financial statements include a balance sheet, which shows the company's assets and liabilities, along with an income statement that shows the company's revenue and expenses. There's also typically a cash flow statement, which shows how cash and cash equivalents like short-term investments are affected by corporate activities. That can be important to investors who want to make sure a company will actually have ample cash on hand to pay its bills.

GAAP and Non-GAAP Measures

GAAP standards are set by an industry body called the Financial Accounting Standards Board. The changing standards say exactly how companies can spell out some officially defined standards such as net income.

Using common accounting standards makes it easier to compare companies' financial statements and makes it harder for unscrupulous or struggling businesses to hide issues by adopting unconventional accounting metrics. Still, some businesses say that GAAP standards don't adequately capture the health of their businesses and may report additional non-GAAP figures on top of GAAP data. Companies can risk scrutiny from investors or the financial press if they report figures that are too unconventional.

Privately held companies have more latitude in choosing what sorts of metrics to report to investors or the public, but many choosing to woo venture capital investors or potential employees may release GAAP metrics to make themselves comparable to publicly held companies. They're generally not required to do so, and small businesses in particular may seek to avoid the costs involved in carefully complying with GAAP standards.

Revenue Vs. Earnings

Two measures of a company's activities that are sometimes confused are revenue and earnings.

Generally, revenue refers to the most inclusive measurement of money coming into a company. Essentially, it's the total sum of all money paid to the company for goods and services that it provides. It's sometimes called the top-line number on a company's income statement, since it's typically reported first and is the number from which other figures are derived.

When people speak about corporate earnings or income, they're usually talking about some kind of measurement of net profit or loss. That is, they're interested in knowing whether the company gained or lost money, all things considered, and how much it gained or lost. Simply knowing the gross revenue of a company won't tell you that, since you won't know how much it spent on whatever goods it sold, on employees or on costs like rent and capital expenses.

Different measurements can be used for earnings, including the GAAP standard net income and alternative measurements like EBITDA. The tax code also has its own definitions for how much income qualifies as taxable for corporations, just as complex rules say how much of an individual's income is taxable.

EBITDA Vs. Net Income

A company's net income measures how much profit or loss it saw after taking into account not only operational expenses, like the cost of goods sold and employee pay, but also other expenses like interest paid on borrowed money, taxes paid to the government and depreciation costs on equipment.

That is often useful information to investors and corporate officers. Even if a company is profitable purely from its operations, that's less important if much of its revenues are still being eaten up by high taxes, interest payments or depreciation on capital equipment.

Still, companies often share a second earnings measurement known as EBITDA, for earnings before interest, taxes, depreciation and amortization. As the name suggests, it adds back in those additional costs and, therefore, is usually higher than traditional net income. Advocates often argue EBITDA provides a clearer view of the health of a company's core business.

Amortization and Depreciation

Amortization and depreciation are technical terms for accounting for the cost of a long-term expense over, essentially, the life of the thing that was acquired.

Depreciation typically refers to the costs of tangible assets that have a limited useful life. For example, a moving company might buy a truck, a software company might buy a new set of computers or a bakery might acquire a new oven. While the business might pay for that expense all at once, the equipment will hopefully outlast the accounting year when it was purchased, so it would be somewhat distorting the picture of the company's financial performance to count those purchases only against one year's net income. Depreciation allows the expense to essentially be paid off for accounting purposes over the useful life of the item.

Amortization typically works similarly, but it's more often used for intangible assets. These can include intellectual property, such as patents and copyrights, as well as things like software licenses. The concepts are essentially the same.

In some cases, particularly for tax purposes, companies can also deduct for depletion of fixed assets, such as oil in a well or ore in a mine, over the course of the life of the mineral deposit.

EBITDA, EBIT and EBT

Two metrics related to EBITDA are EBT, which is earnings before taxes, and EBIT, which is earnings before interest and taxes.

EBT simply adds back in the amount a company paid in taxes to net income. This is sometimes useful for comparing companies operating in different jurisdictions with differing levels of taxes. EBIT adds back in expenses for interest and taxes, which similarly allows for comparing companies that may be affected by different tax regimes and by different costs of borrowing money.

EBITDA also adds back depreciation and amortization to focus strictly on a company's core operations.

Which metric is most useful may depend on exactly what you're trying to analyze about a particular company or set of companies.

EPS Vs. EBITDA

Yet another measurement related to a company's earnings that you may see is earnings per share, usually abbreviated EPS. This generally is computed by taking a company's net income and dividing it by the number of outstanding shares of common stock.

If the company also has preferred stock where dividends are paid out, these dividends are often subtracted from the net income before dividing by the number of shares of common stock. The idea is to give a sense of how much income there would be for each shareholder if the income were divided among the company's owners. Higher EPS is usually a good sign for shareholders, since it means the company is doing well and could pay a healthy dividend to investors.

If EBITDA seems high but EPS seems low, it may be a sign that a company is spending a lot of its income on, well, interest, taxes, depreciation and amortization, meaning that less is actually available for shareholders or expansion of the business.

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Resources (3)

  • Financial Intelligence: A Manager's Guide to Knowing What the Numbers Really Mean; Karen Berman et al
  • EBITDA; iMinds
  • Investment Banking: Valuation, Leveraged Buyouts, and Mergers and Acquisitions; Joshua Rosenbaum et al

About the Author

Steven Melendez is an independent journalist with a background in technology and business. He has written for a variety of business publications including Fast Company, the Wall Street Journal, Innovation Leader and Ad Age. He was awarded the Knight Foundation scholarship to Northwestern University's Medill School of Journalism.


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