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Operating Profit Is Not EBIT: Cleaning EBIT/EBITDA

Updated: Feb 12

Operating Profit


To use Apple as an example. Looking at its operating profit could tell me how profitable its core product is and its ability to control the cost of making its core product, such as iPhones, iPads, Macbooks, etc.


  • I don’t care about the financing cost – If I buy Apple, I will pay off its debt.

  • I don’t care about the Tax – Unavoidable.

So, Operating Profit is the profit before financing and government costs.


Although Operating Profit sounds like EBIT, they are not the same.


For operating profit, it doesn’t count some particular expenses:


  • Non-recurring expenses: Maybe Apple has litigation this year, and that causes expenses.

  • Non-core expenses: Maybe Apple sold its subsidiary, which caused loss or expenses. Apple’s core business is not selling subsidiaries; its core business is making digital gadgets.

  • Non-Controlled holding expenses: Maybe Apple is holding another company’s share of 15%, and expenses from that company occurred. Apple can’t control these expenses because it can not control another company due to its percentage of holding shares.

Predicting the future EBIT/EBITDA is based on the historic EBIT/EBITDA, but only after adding back the non-recurring…


If we add back these three types of expenses, We Get EBIT.

 

EBIT = Earnings Before Interest and Taxes.

EBITDA = Earnings Before Interest, Taxes, Amortization and Depreciation.


Why do some analysts want to add back the D&A in order to get EBITDA figures?


Because within the same industry, maybe the companies' accounting policies are different. One company may depreciate its equipment for five years, while the others may depreciate for ten years, subject to their different accounting policies. Maybe, during the period, one could use a straight-line depreciation method, and others could use a double decline balance method or units-of-depreciation method as well.


So, I don’t care about their accounting policies; I just add back their D&A, Expenses of Non-Recurring, Non-Core, Non-Controlled Holdings, Interests, and Taxes to assess their profitability performance. So, EBIT and EBITDA are important to equity research analysts or other financial statement users.


Be careful of the hidden impairments when adding back D&A.


D&A usually includes impairments, you should check footnote first. You can find D&A in the Cash Flow Statement.


Since you have already added back the impairments to get to EBIT if some impairments are hiding in D&A, adding back the D&A will cause you to double count the impairments. Sometimes, D&A should be called Depreciation & Amortization & Impairments in order to describe the accounts more accurately.

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