EBIT vs. EBITDA vs. Net Income: Valuation Metrics and Multiples

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• published: 23 Jan 2014
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Why Do You Care About This? It's a very common interview question! Q: "How does EBIT differ from EBITDA? What about EV / EBIT vs. EV / EBITDA? When do you use which one? How does P / E compare to those?" By http://breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers" And it's very common on the job as well -- you must decide how to value companies and which metrics / multiples to focus on. What are the Differences Between EBIT, EBITDA, and Net Income? These metrics differ in terms of: 1. Who the Money is Available to -- Equity investors, debt investors, and the government? Just equity investors? Someone else? 2. Operating Expenses vs. Capital Expenditures -- Some metrics reflect the impact of both of these, whereas others only reflect the impact of Operating Expenses and ignore spending on long-term assets. 3. Interest, Taxes, and Non-Core Business Activities -- Some metrics include these, and some exclude them. 4. When They're Useful -- Sometimes you WANT to reflect the impact of CapEx, approximating Free Cash Flow, and sometimes you don't. Same for interest and taxes. Here's the summary of differences, by category: How Do You Calculate It? EBIT = Operating Income on the Income Statement EBITDA = Operating Income on the Income Statement + Depreciation & Amortization from the CFS Net Income = Net Income on the Income Statement They Correspond To... EBIT corresponds to Enterprise Value. EV / EBIT is the multiple. EBITDA corresponds to Enterprise Value. EV / EBITDA is the multiple. Net Income corresponds to Equity Value. P / E is the multiple. Who Has a Claim on the Money? For EBIT and EBITDA, equity investors, debt investors, and the government all have a claim. For Net Income, only equity investors have a claim because debt investors have been paid with interest, and the government has been paid with taxes. What Does It Mean? EBIT = Core, recurring business profitability, before the impact of capital structure and taxes. EBITDA = Proxy for core, recurring business cash flow from operations, before the impact of capital structure and taxes. Net Income = Profit after taxes, the impact of capital structure, AND non-core business activities. Which Expenses Does It Reflect? EBIT reflects operating expenses and the impact of CapEx, but EXCLUDES interest, taxes, and non-core business activities. EBITDA is almost the same, but does NOT include the impact of CapEx. Net Income reflects everything -- operating expenses, CapEx, interest, taxes, and non-core business activities. Which Cash Flow-Based Metric Is It Closer To? EBIT is *sometimes* closer to Free Cash Flow, AKA Cash Flow from Operations -- CapEx, because they both reflect CapEx - but really, only *sometimes* is it closer... EBITDA is *sometimes* closer to Cash Flow from Operations because NEITHER one includes CapEx - but really, only *sometimes* is it closer... And Net Income is generally not close to either one. Which One Do You Use And Why? This is a question with a FALSE premise - you're not just picking one or the other! You'll almost always use a variety of metrics and multiples when valuing companies. So, for example, you might look at EV / Revenue, EV / EBITDA, and P / E all for the same company. But generally speaking, if you WANT to reflect the impact of capital expenditures and it's important to do so for the company/industry you're in, EBIT is better than EBITDA. Whereas EBITDA might be better in an industry where CapEx is less important, such as software/Internet/services/anything else where R&D; exceeds investments in hard assets. But it also depends on a company's state of development -- CapEx is almost always more important to quickly growing companies, whereas it is less important for mature, stable companies! Regardless of the industry. As for Net Income, you usually look at it as a *supplement* to other metrics and multiples -- on its own, it doesn't necessarily give you a great / accurate view of a company because it's distorted by different tax rates, capital structures, and so on. Further Resources http://youtube-breakingintowallstreet-com.s3.amazonaws.com/STLD-LNKD-EBIT-EBITDA-Net-Income.xlsx