EBITDA vs. Operating Income - Choosing the Right Metric

Both EBITDA and operating income are key metrics for understanding a business's financial health. While they both help gauge how well a business is doing, they serve different purposes. 

In today's EBITDA vs operating income comparison, you'll learn the differences between EBITDA and operating income, how to calculate them, and their role in analyzing a business's financial health. 

Let’s get started.

TL;DR - Is EBITDA the Same as Operating Income?

Let's start with a quick overview:

When selling your business, deciding how to use EBITDA and operating income can be confusing. That’s why you'll need the help of experts to calculate the two metrics accurately and use them correctly to inform the sale. 

You can hire M&A experts like financial accountants to help you, but you also need other experts such as wealth advisors, investment bankers, and M&A attorneys to help you with other aspects of the sale. 

At Exitwise, we connect you with the top M&A professionals within your industry to help you maximize the value of your business and the exit.

Reach out to us today to optimize your business exit, selling faster and at the best price possible. 

What Is EBITDA in Business?

EBITDA refers to a business's earnings before interest, taxes, depreciation, and amortization. Businesses primarily use this metric to measure their operational efficiency and ability to generate cash from core operations.

How to Calculate EBITDA

Here's the formula for calculating EBITDA:

EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization

Where;

• Net Income is the remaining profit after all operating expenses

• Interest includes interest paid on debt

• Taxes include any income tax or other taxes paid in the specific period

• Depreciation is a non-cash item showing the loss in the value of the business's tangible assets over time

• Amortization is a non-cash item showing the loss in the value of intangible assets over time

EBITDA Example

Let's calculate EBITDA using the data below:

• Net Income: $550,000

• Interest: $40,000

• Taxes: $90,000

• Depreciation: $120,000

• Amortization: $60,000

EBITDA = $550,000 + $40,000 + $90,000 + $120,000 + $60,000 = $860,000

You can use our free business valuation calculator to determine your business's worth based on its EBITDA. 

What Is Operating Income?

Operating income is a business's actual profit after subtracting operating expenses from gross profit. Such expenses include utilities, rent, salaries, wages, and research and development. 

How to Calculate Operating Income

You can calculate operating income using the formula below:

Operating Income = Gross Profit - Operating Expenses

Where;

• Gross Profit = Net Revenue - Costs of Goods Sold (COGS)

Operating Income Example

Here's a sample calculation based on the following data:

• Net Revenue: $390,000

• Cost of Goods Sold: $223,000

• Research and Development: $20,000

• Selling, General, and Administrative Costs: $25,000

Gross Profit = $390,000 - $223,000 = $167,000

Operating Income = $167,000 - 20,000 - 25,000 =$122,000

EBITDA vs. Operating Income — Core Comparisons

Here's how EBITDA and operating income compare based on different aspects:

EBITDA and Operating Income Differences

From the above table, we can observe the following differences between EBITDA and operating income:

• Standardization: Operating income is a GAAP metric, while EBITDA isn't. 

• Purpose: While both focus on core business operations, they differ slightly in what they measure. EBITDA measures the ability of a business to generate cash flows and profits, while operating income focuses more on actual profits. 

EBITDA and Operating Income Similarities

Despite the differences, there are also a few similarities between the two metrics:

• Both metrics require other financial metrics to present a fuller picture of the overall financial health of a business.

• Both metrics focus on core business operations. 

• Both can measure a business's profitability as well as operational efficiency. 

• Both do not consider the cost of taxes and interest. 

Operating Income vs.  EBITDA — Which Metric Should You Use?

The metric you choose between operating income and EBITDA depends mainly on the purpose for which you calculate it. 

If you just want to highlight your business's actual profits, you can use operating income. 

If you want to showcase your business's potential to generate earnings and profits, you can use EBITDA. 

EBITDA is also better if you are considering selling your business because it provides a higher valuation potential. 

What About Net Income?

Net income is the final profit that remains after removing all business expenses, including taxes. Depending on the business, net income may include non-operating expenses and non-operating sources of income, like interest income. 

Unlike EBITDA and operating income, net income accounts for expenses on taxes and interest (cost of debt). 

Here's the formula for net income:

Net Income = Earnings Before Taxes (EBT) - Taxes

Net income is better than operating income for measuring a business's actual profits or bottom line.

Frequently Asked Questions (FAQs)

Let's close this operating income vs EBITDA discussion with a few common questions around the topic:

Is Operating Income the Same as EBIT or EBITDA?

Operating income is the same as EBIT since they both mean the same thing. But it's different from EBITDA. 

Operating income represents actual profits after subtracting operational expenses, while EBITDA measures core profitability after adding back interest, taxes, depreciation, and amortization. 

Can a Company Have a High EBITDA But Low Operating Income?

Yes. EBITDA is typically higher than operating income since it doesn't subtract depreciation and amortization. 

Operating income subtracts these and other expenses. 

Is EBITDA or Operating Income More Useful for Small Businesses?

The usefulness of EBITDA and operating income to a small business depends on the purpose of calculating the metric. 

If the purpose is to value the business before an exit, EBITDA is more important because EBITDA is more common among potential buyers as a relative valuation metric than operating income. 

Operating income is more useful if you just want to highlight your business's actual profits, which can be for internal or external purposes.

Conclusion

We've seen how EBITDA and operating income differ even though they both focus on a business's core operations. EBITDA focuses more on the ability to generate cash flows and profits, while operating income focuses more on the actual profits. 

When it comes to selling your business, you'll want to focus more on EBITDA for the following reasons:

• It offers a more vivid picture of cash flow by excluding non-cash items (depreciation and amortization)

• It's more widely used in business valuations and M&A transactions

• It gives a higher valuation potential

• It easily attracts potential buyers focused on cash flow generation potential

The bottom line is that working with both metrics can be confusing, necessitating the input of financial accountants.

However, a business sale requires more than financial accountants. You'll also need M&A attorneys, wealth advisors, and investment bankers. 

Fortunately, Exitwise is here to help you find the best M&A experts specific to your industry. We'll even negotiate better fees and terms of engagement with them on your behalf!

Consult with our team today to actualize the business exit of your dreams.