Operating profit and EBITDA, or earnings before interest, tax, depreciation and amortization, are two indicators of profitability. These two indicators are related but give different insights into the financial health of the company.
Operating profit margin is a profitability ratio that investors and analysts use to assess a company’s ability to turn a dollar of revenue per dollar of net profit after accounting for expenses. In other words, the Operating margin is the percentage of revenue remaining after accounting for expenses.
Two components go into the calculation of operating profit: revenue and operating profit.
The company was on the top line on the income of the company and represents the total income generated from the sale of goods or services. The company also called net sales.
Operating profit is the profit remaining after all the day-to-day expenses were removed from sale. However, some costs are not included in operating profit such as interest on debt, taxes paid, profit or loss from investments, and any extraordinary gains or losses, which occurred outside the company’s daily activities, such as selling assets.
Day-to-day expenses, included in calculating the operating profit include the wages and benefits for employees and independent contractors, administrative costs, cost of spare parts and materials necessary for the production of goods the company sells, advertising costs, depreciation and amortization. In short, all costs necessary to keep the business running, such as rent, utilities, salaries, employee benefits, and insurance premiums.
While the operating profit is the amount of profits earned during the period, operating profit margin is the percentage of revenue the company earns after taking out operating expenses. The formula is as follows:
Examining the Operating margin helps companies to analyze, and hopefully reduce the variable costs involved in the conduct of its business.
EBITDA or earnings bbefore Iinterest, taxes, depreciation, and inmortization is a little different from operating profit. EBITDA does not include the cost of capital and its tax implications by adding interest and taxes to net profit. EBITDA also excludes depreciation and amortization, non-cash means of earnings.
Depreciation is a method of accounting for the attribution of the cost of the asset over its useful life and is used to account for the decline in value over time. In other words, depreciation allows the company through long-term asset purchases for many years, helping the company to generate income from placement of assets.
Amortization and depreciation are deductible from income when calculating operating profit. EBITDA, on the other hand, adds depreciation back to operating profit, as shown by the following formula:
EBITDA = operating profit + depreciation
EBITDA helps to show the company’s operating activities, before accounting expenses, like depreciation is not being taken out of operating income. EBITDA can be used to analyze and compare profitability among companies and industries as it eliminates the effects of financial and accounting solutions.
For example, capital-intensive enterprise with a large number of fixed assets will have a lower operating profit due to the depreciation of the asset compared to a company with fewer fixed assets. EBITDA removes depreciation so that the two can be matched without any accounting, the factors affecting profit.
For additional operating income and EBITDA, including examples, please read what is considered a healthy operating profit margin? But as gross profit and EBITDA are different?