Home Finance Understanding Ebitda vs Gross Profit

Understanding Ebitda vs Gross Profit

Ebitda vs Gross Profit

There are two ways to measure your company’s earnings: gross profit or EBITDA (earnings before interest, taxes, depreciation, and amortization). While the two are used for similar purposes, they calculate differently and can show different analytics of your company.

You may not see the big deal between EBITDA and gross profit and that’s okay. Even here, you won’t see one method being praised and the other frowned upon. Instead, this is just a guide to get you started on using one or both.

If you are confused about gross profit and ebitda calculator excel spreadsheets, here’s a quick and easy way to understand both concepts.

Understanding Gross Profit

Quite simply, gross profit is the amount earned by a company or business after you subtract all costs involved in production. Gross profit doesn’t factor in the amount you spend on corporate offices or after-production expenses, though, so don’t be tricked into thinking all of your costs are incorporated.

Gross Profit Formula

Gross profit has its own unique formula, just like EBITDA will have further down. In order to find your gross profit, use the following formula:

Revenue – Cost of Goods Sold = Gross Profit

In this case, your revenue will be the complete amount you’ve earned from your product. You may also hear the term net sales used in reference to revenue and this is correct as well. Your revenue may also include any discounts or deductions you’ve made during this time. So yes, the first thing you’ll need is your revenue or net sales.

Next, you’ll need to take into account the cost of goods sold. This is everything you purchased or had to pay for in order for production to start or continue. Direct materials, production labor costs, and anything else that is immediately linked to the production costs will be added up to make the cost of good solds (COGS).

Here’s an example of what the gross profits may look like for Company A:

$2.04 billion in revenue – $1.1 billion in cost of goods sold = $940 million in gross profits.

Keep in mind that your gross profit is not your profit after taxes, deductions, or other labored work costs. For this reason, gross profit is best for when you want to analyze the financial performance of your revenue and ability to manage production related costs. If you are looking to analyze the financial performance as well as operating costs, then you’ll want to turn to EBITDA.

Understanding EBITDA

EBITDA (Earnings before interest, taxes, depreciation, and amortization) is different from gross profit. It is used for slightly different purposes, but still indicates a company’s financial performance.

When using EBITDA, you can take out the debt capital, tax effects, depreciation, and amortization. You’ll add back in interest and taxes to earnings, but it’s a great way to analyze your company’s profitability.

EBITDA Formula

EBITDA has a unique formula that doesn’t use any of the same aspects as gross profit. In fact, the formula for EBITDA is just a bunch of addition! Here it is below:

Operating Income + Depreciation + Amortization

Your operating income is the profit of your company after you subtract all operating expenses and daily business costs. When using your operating income, your business can separate the earnings from your operating performance.

Here’s an example of how your EBITDA formula might look if used by the same Company A:

They have an operating income of $2 million and a depreciation of $94 million. However, part of their operating income has already included the subtraction of their depreciation (original operating income – $94 million = $2 million in current operating income calculation).

In order to finish the formula, depreciation and amortization need to both be added back into the operating income. This leaves us with a total of $96 million for the EBITDA.

Comparison

As you can see, your company’s gross profit and EBITDA are going to be quite different. While the gross profit for Company A was $940 million, the EBITDA was only $96 million. It’s important to keep these differences in number in mind when choosing between which formula to use. Both formulas help analyze your company’s finances, but in slightly different ways.

If you’re trying to decide whether to use a gross profit formula or an EBITDA formula, there’s no right or wrong answer. You can use both if you so desire, but your choice should take into consideration what outcome you’re looking to see.

EBITDA will show your company where to strip out management decisions and potential manipulation whereas gross profit will show production efficiency for larger retailers.

Both methods have their pros and cons. For a company that has many fixed assets, an EBITDA calculation will likely inflate your income by not taking into consideration your depreciation expenses. Companies that don’t have many fixed assets or are based largely in retail, the lack of account for depreciation may not matter all that much.

Conclusion

It’s always possible to use both calculation methods for your company. Since gross profit will show a slightly different aspect of your business than EBITDA will, it may be valuable to use both and see the differences. In the end, there’s no real right or wrong choice. It all comes down to what area of your company you want to analyze and how you want to show it.

LEAVE A REPLY

Please enter your comment!
Please enter your name here