Sep 22, 2021 FINANCE 101

In the previous, we used net profi­t to measure corporate performance. Although net pro­fit has merits – it’s a powerful measure for thinking about how shareholders have been doing – it has problems.

First, it treats cash and non-cash expenses symmetrically.

Second, net profi­t also subtracts interest payments, which makes it hard to compare companies that fi­nance themselves in different ways even though their operations could be quite similar.

Revenue similarly may need to be recognized over time. But this process of smoothing measures of performance is subjective, which allows managers to manipulate profi­ts to their advantage. In contrast, cash is cash and, arguably, is not susceptible to similar levels of managerial discretion.

EBIT Equation:

EBIT = Net Profit + Interest + Taxes

As we saw, EBIT (or operating pro­fit) gives a clearer view of how effi­cient and profi­table a company is relative to net profi­t by not subtracting interest and taxes, which are not related to operational performance. EBIT still isn’t quite a measure of cash, however, because it is calculated after subtracting non-cash expenses such as depreciation and amortization.

For a fuller picture, fi­nance professionals turn to EBITDA: earnings before interest, taxes, depreciation, and amortization.

EBITDA Equation:

EBITDA = Net Profit + Interest + Taxes + Depreciation and Amortization

Amazon’s Net Profit, EBIT, and EBITDA

Amazon provides a compelling example of the distinction between these three different measures. In 2014, Amazon’s net profi­t was −$241 million. Amazon’s EBIT, however, was $178 million, and the difference of $419 million represents taxes, interest, and currency adjustments. What about EBITDA? Because of a whopping $4.746 billion in depreciation and amortization, the EBITDA here is $4.924 billion—a far cry from the net loss of $278 million. So, Amazon generated lots of cash, as measured by EBITDA, but had losses according to pro­fitability measures.

By thanhnambui

I am a bank employee specializing in trade finance- a field that is not directly linked to my university major in Financial Investment. However, with a passion for economics and finance, I determined to pursue a higher education degree and successfully achieved a Master in Economics of Banking and Finance from CFVG in 2019. During that study time, I encountered many difficulties in consolidating background knowledge studied at university, which made me realize the necessity of building foundation for effective learning outcomes. Therefore, my friend and I decided to create Econfin-Invest to record basic knowledge of economics, banking, finance, and investment fields. The articles I write are carefully selected and collected from a wide range of different reliable sources such as textbooks, economic and financial reports and relevant journals. Most importantly, these articles are not A to Z lectures of subjects related to the aforementioned fields, yet simply articles I consider to be accessible to all interested readers as well as being essential to apply in everyday practices. Thank you for reading and supporting!

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