When running a startup or small business, understanding your finances isn't important – it's necessary. But when it comes to metrics like EBITDA and net income, things can get confusing.
At first glance, they look pretty much the same, but knowing the difference can make or break your decision-making process.
In this article, we'll demystify the difference between EBITDA vs net income and show simple formulas to calculate them. Keep reading to learn more.
To explain EBITDA, we should briefly describe the main difference between net income vs. EBITDA.
It’s all about the costs they consider. Net income (the “bottom line”) is what’s left when you subtract all expenses like taxes, interest expense and the wear and tear on assets from the company’s total revenue.
On the other hand, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) ignores these costs and only measures the profitability of the business's regular operations.
It's similar to EBIT, which excludes interest and taxes.
Therefore, EBITDA measures a company's profitability—a higher EBITDA usually means the company is more profitable.
EBITDA calculation is fairly straightforward. The formula for calculating EBITDA reads:
In this formula, the operating income refers to earnings or net income, interest and tax expenses. We’ll discuss each part of EBITDA further in the following sections.
Interest and taxes are expenses that aren't directly related to a company's core business. When you add these costs to net income (or earnings), you get EBIT. To calculate EBITDA, you also add depreciation and amortization, but more on that in a second.
A business pays interest on money it has borrowed. Common sources of interest costs include:
Taxes are payments that businesses make to the government. These include:
Income tax is usually one of a company's primary tax expenses. When calculating EBITDA, all these non-operating expenses are added back to earnings.
Depreciation and amortization are ways to account for the loss of value in assets over time.
Depreciation is the decrease in the value of a physical asset. A simple example is when a car loses value as it gets older.
Amortization, on the other hand, is about gradually writing off the cost of intangible assets, like a customer list that becomes less useful over time.
In short, depreciation is the loss of value in physical items, while amortization is spreading out the cost of non-physical things.
Adjusted EBITDA is a way to measure a company's financial performance by removing one-time, unusual or non-recurring items from EBITDA.
The purpose of adjusted EBITDA is an accurate, consistent number that isn't affected by unusual events or special items. Financial professionals like analysts and investment bankers often use this figure to assess a company's value.
The specific adjustments vary depending on the industry and company. They can include special donations, legal expenses, non-cash expenses and others.
EBITDA is used in industries like SaaS and other fast-growing sectors to show how much money a company can make from its core activities, without getting mixed up with extra costs like interest and taxes.
This valuation helps investors see the company's earnings potential and its core operations performance.
It focuses on the company's ability to make money by ignoring costs like depreciation and amortization expenses, which aren't directly related to day-to-day business activities.
It’s also easy to calculate by adding back interest, taxes, depreciation and amortization to net income, which makes it a quick and straightforward tool for financial analysis.
Additionally, EBITDA is commonly used to evaluate a company’s value through financial ratios that compare EBITDA with the company’s overall worth.
To learn more about business valuation, check out what investors really want from early-stage startup finances.
Net income, also known as net profit or just earnings, is what’s left after all expenses have been deducted from a company's revenue. It represents the company's profit.
Net income is the “bottom line” because it's the final figure on the income statement. This number is also the first item on a cash flow statement. You can find net income on your financial statements.
Same as EBITDA, net income also has a simple formula:
Net income can be either positive or negative. If your company's revenue is higher than its expenses, you have a positive net income. If your expenses exceed your revenue, you end up with a negative net income (or a net loss).
You can calculate your company’s net income for any period, like annually, quarterly or monthly, depending on what works best for your startup financial model.
If you're a new business owner, these similar-looking terms are probably causing you headaches. Here are some tips to help you distinguish between them:
Net income is useful across all businesses. It shows the company’s total profit after all expenses, including interest and taxes, have been subtracted.
This figure clearly shows a company’s profitability after all deducted expenses. Think of it as the final score showing whether the company is making money or losing it.
Net income also meets accounting rules and is needed for official financial reports. For investors, it’s a simple way to see how profitable the company is and how likely it is to pay dividends.
Choosing between net income vs EBITDA for measuring business financial performance depends on what you want to look at:
So, EBITDA is best for assessing operational performance and making comparisons, while net income provides a complete view of a company’s financial health.
However, to fully understand a company’s financial performance, it’s best to look at both financial metrics. Of course, they’re not the only ones you should track as there are many other indicators of your company’s performance.
Check out this article to learn more about other key SaaS metrics you should track.
EBITDANet incomeDefinitionEBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. It measures a business’ profitability from its regular operations without considering expenses.Net income is the totalt after deducting all expenses from a company's revenue. It’s the company's total profit.
UseIt helps you see how well a company is performing in its core operations. It’s used to evaluate a company’s value through financial ratios. It’s helpful for industries like SaaS and other fast-growing sectors.Net income is the totalt after deducting all expenses from a company's revenue. It’s the company's total profit.FormulaEBITDA = Operating income + Depreciation expenses + Amortization expensesNet income = Revenue - COGS - Expenses
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No, EBITDA is the money a company makes before subtracting interest, taxes, depreciation and amortization expenses. Because these costs are not included, EBITDA is usually higher than net income.
No. Gross profit is what’s left after subtracting the costs of making products or providing services. EBITDA, on the other hand, shows how much a company earns before accounting for interest, taxes, depreciation and amortization.
Net profit is the final amount of money a company makes after subtracting all expenses, including taxes and interest. EBIT, on the other hand, looks at earnings from core operations before these additional costs are taken out, so it focuses more on how well the business is performing without considering taxes and interest.
No. EBITDA should never be higher than a company's total revenue because it’s calculated after subtracting some operating expenses from the revenue. It's usually lower, but in some cases, they can be equal.
