Operating Income vs EBITDA

What Is Operating Income?

Operating income is a term used in accounting to refer to the amount of money earned by an entity by providing goods or services, before subtracting costs for items such as depreciation or rent on real estate. For example, if you own a restaurant that had $100,000 in sales during this quarter and $20,000 worth of food costs, it would have a gross profit of $80,000 ($100,000 minus $20,000). The net profit is the difference between your total revenue and your costs. In this case netting out with $80,000 in income also equals operating income.

How to Calculate Operating Income

To figure out your operating income, you will need to determine your total revenue and subtract all of the costs associated with running the business. To do so: Find your total revenue by adding up all of your sales and other income or cash in if you are a service based business. From there, add up any costs associated with providing this product or service. For example, if you are a restaurant or retail shop, include the cost of inventory, food costs and labor costs in your total revenue. If you are an online business, include subscription fees for internet services. Once you have all the necessary numbers totaled up, subtract it from your gross income to find your operating income. Thus, operating income is calculated by taking total revenue minus operating expenses. Operating_Income_Formula For example, Company ABC has total revenue of $1,000,000 and operating expenses of $500,000. The company’s operating income is $500,000 ($1,000,000 minus 500,000).

What Is EBITDA?

EBITDA stands for “earnings before interest, taxes, depreciation and amortization”. Basically, it is a way to estimate a business’s performance and is used as an alternative to measuring a company’s net income. Many investors and lenders use EBITDA as a measure of financial performance because it is simple, quick and easy to determine. EBITDA values are commonly presented in business plans or during interviews to give an idea of cash flow without too much detail or explanation needed. However, this financial ratio can be misleading because it doesn’t take a lot of details into consideration. Many companies can use certain legal or accounting strategies to make their EBITDA seem better than what it really is. For example, marketing expenses or costs of acquiring new clients may be included as part of operating expenses even though they aren’t used in the day to day operations of the business.

How to Calculate EBITDA

To calculate EBITDA you will need to follow these steps: Start with the operating income from your income statement and add back in any extraordinary or unusual charges, such as a loss on a sale of equipment, expenses from an accounting error, restructuring charges and/or litigation expenses. Determine how much depreciation you will add back in and add that value to the operating income too. Also add interest expenses back into your EBITDA calculations. If a company has net income, then it pays taxes on its earnings which means that the business also paid interest expenses during this time period, and these must be added back when calculating EBITDA. This EBITDA formula looks like this: EBITDA_Formula For example, Company XYZ has an operating income of $200,000. If this business spent $15,000 in depreciation and $50,000 for interest expenses during the same year, then it would calculate EBITDA like this: EBITDA = 200, 000 + 15,000 + 50,000 EBITDA = $265, 000 Another way to calculate EBITDA is by adding back interest, taxes, depreciation and amortization into your operating income. This EBITDA formula looks like this: EBITDA_Formula_2 This is not as common, but can still be useful in certain situations.

Key Differences Between Operating Income and EBITDA

Operating income measures the profitability of operations while EBITDA focuses on the overall earnings potential for a business by looking at its operational efficiency, liquidity and asset usage. There are two major differences between these two financial metrics:

  1. Operating income calculates the earnings before operating expenses and depreciation, while EBITDA adds back in taxes and interest to get a more complete picture of the business’s financial performance.
  2. Operating income provides insight into profitability based on operations, while EBITDA focuses on the ability for a company to generate earnings before taking other factors into consideration, which are related to capital structure.

When Should You Use One Over the Other 

Both operating income and EBITDA are helpful tools when analyzing the performance of a company, but it really depends on what you are looking for or trying to figure out. If your goal is to get an idea of how effective a company is at generating cash flow, then EBITDA is a good option to choose. If you want to get a better picture of the financial performance of a business, then operating income is a better choice. For example, let’s say that Company XYZ’s operating income was -$200,000 and its EBITDA was $265,000. Since operating income is negative, this means that the business lost money. However, EBITDA looks better since it’s positive and shows that the company was able to turn a profit. It’s important to keep in mind that both of these metrics can be manipulated by changing accounting methods or using different definitions for charges. This is why it’s important to look at both metrics when evaluating a business. It’s also a very good idea to compare the two numbers to those from previous years and across similar companies in order to validate the metrics. In general, you should use operating income if you are looking for a more accurate picture of how well the business is performing from an operational standpoint, while EBITDA is more useful when examining the earnings potential of a company.

Operating income measures the earning power of a business, and it accounts for all regular revenue sources and deducts all expenses except interest and taxes. It excludes exceptional gains or losses such as lawsuits, legal judgments, unusual gains or losses on investments and real estate sales.
Operating income takes into account the total revenues from a company’s operations and deducts all expenses that can be attributed to its main business activities.
Earnings before interest, taxes, depreciation and amortization (EBITDA) takes a more comprehensive look at a company’s financial performance because it combines all sources of income statement expense into one number. In addition to regular expenses, EBITDA also includes charges from capital structure such as interest and taxes.
Operating income provides insight into how profitable operations are, while EBITDA focuses on the earnings potential for a company based on its operational efficiency, liquidity and asset usage. The biggest differences between these two metrics include: how they are calculated, where items such as taxes and interest appear and what types of costs they include.
It depends on what the goal is. If the purpose of calculating these metrics is to get a good sense of how effective a company is at generating cash from its operations, then EBITDA is the better option. If you are looking for an accurate picture of profitability based on operations, then operating income is a better option.

True Tamplin, BSc, CEPF®

About the Author
True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.