EBITDA vs Net Income

By Sean Stevenson – Latest Revision March 7th, 2021

Just What Are EBITDA And Net Income?

EBITDA and net income are important indicators that can help determine the overall financial health of a company. 

Prospective investors often compare EBITDA and net income.  In general, this allows them to get a better overall sense of how well an organization is performing in terms of its profitability.

They key difference between EBITDA vs net income, is that EBITDA refers to earnings within a specified period of time before considering various expenses.  Conversely, net income takes into account operational expenses incurred by the company.

EBITDA and net income can be thought of as the “before and after” metrics of a company’s financial profitability.  Many income or financial statements will often list both the EBITDA and net income for reference.

Defining EBITDA

EBITDA is actually an acronym that stands for earnings before interest, taxes, depreciation, and amortization.  It is an important metric that is often used for determining the profitability of a given business model.

The inherent model of EBITDA allows for raw profitability to be calculated.  This means that additional costs such as financing (interest), taxation, depreciation, and amortization are not included.

A key advantage of EBITDA is that it provides a simplistic technique for deeper analysis.  A business model’s raw profitability can be calculated with EBITDA, by only using your company’s cash flow statement and/or income statement.

The formula for calculating EBITDA is as follows:

EBITDA vs Net Income

Adding operating profit, amortization, and depreciation, will give you the EBITDA.  This represents the raw profitability of a given business model.

Defining Net Profit

Net profit (also called net income) differs from EBITDA.  It represents the total earnings of a company, minus any and all existing expenditure.

Net profit takes into account the operating costs, the cost of goods sold (COGS), deductions, along with any additional expenses including interest, and taxation.

Net profit as opposed to EBITDA is useful, in that net profit shows the exact amount of financial gain earned after all liabilities have been dealt with.  It is the final “sum” that the business has gained from its operations, after dealing with its obligations.

The formula for calculating net profitability is:

EBITDA vs Net Income

Subtracting revenue from all business expenses (including operation and taxation) will give you the net income.

Advantages and Differences Between EBITDA Vs Net Income

  1. Both EBITDA and net income are calculated using the income statement. Prospective investors should use both of these, along with other indicators and metrics, when determining the optimal investment available to them.  For example, it is advisable to also make use of the ROIC, balance sheet, and cash flow statement, among others.
  2. EBITDA indicates the profits made by a business model before it pays taxes, operating expenses, amortization, and depreciation. Conversely, net income profitability takes into account the total expenditure of the organization after it pays its taxes, operating expenses, amortization and depreciation. 
  3. EBITDA is useful for analyzing the unbridled profits incurred by a business structure (including any potential earnings). Whereas net income can be used to discover the earnings per share (EPS) of a business model.
  4. EBITDA is flawed in that it does not take all expenses into account. Some of these expenses may be significant.  This can create a situation where cash flow is misrepresented as profitable, when in reality expenditures may negate this.  Misrepresentation can occur in financial statements, when the EBITDA is overemphasized, and the net income is ignored.
  5. It is not uncommon for prospective investors to ignore net income and focus on EBITDA. This is because they are looking at earnings potential, rather than fully realized “net” earnings.
  6. For the purpose of sticking to fundamentals while investing, it is highly advisable to pay close attention to the net income, rather than the EBITDA. This is due to the fact that the net income will reveal the fully realized profitability of a business after all expenses (including taxation) have been considered.  In short, it provides a much more accurate and reliable depiction of a business’ practices in the marketplace.

Using EBITDA and Net Income

For personal or business use, both of these metrics can provide deeper insights into the nature of your practice.  It is in fact, advisable to use both EBITDA and net income.  This will provide you with far deeper insights into the nature of your own process.  Using only one of the two would only give you “half” of the financial picture.

EBITDA vs Net Income

Above, we see depicted the process of EBITDA, which then dovetails into net income.  By analyzing your EBITDA in relation to your net income, you can determine where the pitfalls or harshest expenditures exist. The EBITDA represents the raw profitability of a business.  Conversely, the net income takes into account the operational expenditures of doing business.  In effect, the EBITDA is the “before expenses,” whereas the net income is the “after expenses.”

By analyzing and comparing your EBITDA and net income, you will be able to discover ways to improve upon your existing business process.  It can offer deeply revealing insights into where your weaknesses are, and how to go about fixing them.

It is advisable to analyze your EBITDA and net income quarterly.  At the very least, an annual comparison will help you to better understand your financial picture. 

Using the EBITDA vs net income comparison, try to:

  • Improve your potential profitability.
  • Control expenses wherever possible.
  • Find better ways of managing your financial picture.
  • Continuously develop new methods and opportunities for growth.

History of EBITDA Vs Net Income

EBITDA first became popular in the 1980’s with the rising interest in Leveraged Buyouts.  As a financial instrument, EBITDA was particularly useful during this period.  It offered a key insight into the potential profitability of companies that were being looked at for acquisition by larger enterprises.  Analysts would regularly use it in determining pricing and viability.

Net income has been around for a very long time.  In fact, if you look net income up, you will quickly discover that nobody is quite certain when it was first invented.  Some maintain that individuals have always used net income to determine their personal profitability the marketplace.  There are however, records dating back to before the 1700’s, which show a clear interest in net income as a going concern.

Both EBITDA and net income have been used in differing variants throughout human history to help determine important measurable metrics.  These can then be used to alter or improve an existing business model.

With meticulous use of EBITDA and net income, you can create a better financial situation for yourself or your business.

Conclusion - EBITDA Vs Net Income

Both EBITDA and net income are useful financial terms and indicators that can be used for better financial decision-making.  Moreover, prospective investors and analysts can make good use of them when seeking to understand the profitability associated with different business models.

While EBITDA and net income can both prove very useful, they are best used in tandem with as many other metrics as possible.

Remembering that the fundamentals of investing require a contrast of information, is key to any successful venture!

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