Gross profit and EBITDA (earnings before interest, tax, depreciation, and amortization) both measure the profit, or earnings, of a business. However, they do so in different ways.
As a business owner, you may want to use both metrics to get a full picture of your company’s revenues and how efficiently it is operating so you can make the smartest choices, especially when considering small business financing.
Read on to learn the difference between gross profit and EBITDA, how each metric is calculated, and which one to use when.
What Is Gross Profit?
Gross profit is the total income a business earns after deducting the cost of goods sold (COGS) from its total revenue. COGS includes any of the expenses that are directly involved in creating a product or service, such as materials, labor, and equipment.
Gross profit tells you how much profit a business receives from its direct labor and materials. The higher the gross profit, the more efficient the business is at producing its core products and services. Gross profit is the first profit figure on a business’s income statement.
While gross profit accounts for costs directly involved with products or services, it does not include expenses that are not directly involved in production, such as salaries for administrative staff, rent for a corporate office, office computers, and marketing expenses.
How Is Gross Profit Calculated?
The formula to calculate gross profit is as follows:
Gross Profit = Revenue – COGS
Revenue is the total income derived from the sale of products or services. COGS refers to the direct costs of producing the goods sold by a company. When you subtract COGS from revenue, you end up with gross profit.
Gross Margin vs Gross Profit
Gross profit margin (or gross margin) and gross profit mean essentially the same thing – they both show the amount of revenue left after covering the COGS. The only difference is in how they are expressed: Gross profit is shown as a dollar amount, whereas gross margin is shown as a percentage.
Once you have your gross profit, you can express it as gross margin by dividing gross profit by your total revenue:
Gross Margin = Gross Profit / Revenue x 100
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What Is EBITDA?
EBITDA calculates earnings before interest, tax, depreciation, and amortization. It specifically shows a business’s operational profitability because it only takes into consideration those expenses necessary to run the business day-to-day.
If you’ve taken out various kinds of small business loans, EBITDA will paint the picture of what your company’s financial performance is outside of that debt. EBITDA also excludes expenses that are outside of a business’s control, including taxes, depreciation (a decrease in the book value of assets over time), and amortization (allocating the cost of an intangible asset over a period of time).
By eliminating the effects of financing and accounting decisions, EBITDA can be useful for comparing profitability among companies and industries.
While EBITDA is often confused with cash flow, these are two different concepts. Cash flow generally refers to the money that flows through a business, both in and out.
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How Is EBITDA Calculated?
There are two ways to calculate EBITDA.
Option 1:
Start with net income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation, and amortization.
EBITDA = Net income + Taxes Owed + Interest + Depreciation + Amortization
Option 2:
Start with operating income (amount of revenue left after deducting the direct and indirect operating costs from sales revenue), then add depreciation and amortization.
EBITDA = Operating Income + Depreciation + Amortization
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EBITDA vs Gross Profit Compared
EBITDA and gross profit have a few things in common, but there are also some key differences.
Similarities
Both gross profit and EBITDA are financial measurements of how profitable a company is once certain costs and expenses are removed.
Investors can look at both of these numbers to understand whether a business would make a good investment or not. Company management can use these numbers to evaluate performance and plan for future profitability.
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Differences
EBITDA and gross profit measure profit in different ways. Gross profit is the profit a company makes after subtracting the costs associated with making its products or providing its services, while EBITDA shows earnings before interest, taxes, depreciation, and amortization.
Gross profit is useful internally, as it can help a company understand how well it’s using its resources to generate profit from products or services. Outside investors and creditors may be more interested in EBITDA if they want to compare your business to another, or to your industry as a whole.
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EBITDA vs Gross Profit Compared
| Gross Profit | EBITDA | |
|---|---|---|
| Who uses it? | Business owners, analysts, and investors | Business owners, analysts, investors, and creditors |
| Part of income statement? | Yes | No |
| How it’s calculated | Total revenue minus COGS | Operating income plus depreciation and amortization |
Example of EBITDA vs Gross Profit/Margin Calculation
Here is an example of how you would calculate EBITDA vs. gross profit and gross margin.
Let’s say you have an annual revenue of $1,000,000 at your shoe factory. The cost to make shoes – COGS – over a year is $25,000. Your operating income is $925,000. Additionally, you have these expenses:
• Interest on a loan: $1,000
• Taxes: $10,000
• Depreciation: $4,000
• Amortization: $5,000
To calculate your gross profit, you would use this formula:
Revenue ($1,000,000) – COGS ($25,000) = Gross Profit ($975,000)
Gross margin is shown as a ratio:
Gross Profit ($975,000)/ Revenue (1,000,000) x 100 = Gross Margin (97.5%)
To calculate your EBITDA, you would use this formula:
Operating Income ($925,000) + Depreciation ($4,000) + Amortization ($5,000) + Tax ($10,000) + Interest ($1,000) = EBITDA ($945,000)
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Pros and Cons of Using Gross Profit/Margin
Using gross profit to measure a company’s profitability has both pros and cons. Here’s how they stack up.
| Pros of Using Gross Profit/Margin | Cons of Using Gross Profit/Margin |
|---|---|
| Quick way to show a company’s efficiency | Doesn’t show a company’s profitability |
| Provides a benchmark for comparing a company’s performance year-over-year and to its competitors | Doesn’t factor in all costs |
| Can use for any type of operating expense | May require collateral |
| Highlights areas for improvement | Less valuable for comparing companies in different industries |
Gross profit assesses a company’s efficiency in terms of making use of its labor, raw materials, and other supplies. An increase or decrease in gross profit over a period of time can help business owners and managers determine the reason for the fluctuation and, if necessary, take corrective action.
However, gross profit should not be confused with overall profitability. That’s because this metric does not factor in the fixed cost of running a business, such as rent, advertising, insurance, office supplies, and salaries for employees not directly involved in production, and office supplies.
The Takeaway
Gross profit and EBITDA are two different ways to measure a company’s profitability. Gross margin shows profits generated from the core business activity, while EBITDA shows a business’s earnings before interest, taxes, depreciation, and amortization.
Business owners can benefit by knowing both. Calculating your gross profit can help you see how efficiently your company is using its labor and materials. Knowing your EBITDA can show you how your business compares to other companies in your industry. EBITDA may also come into play if you’re applying for a business loan. Lenders will often look at EBITDA (as well as annual revenue, net income, and credit score) to gauge the financial health of a business.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
FAQ
Does EBITDA represent gross profit or net profit?
EBITDA (earnings before interest, tax, depreciation, and amortization) doesn’t represent either. However, it is closest to net profit. To calculate EBITDA, you take a company’s net profit (gross income minus expenses) and then add interest, taxes, depreciation, and amortization back.
How can you calculate gross profit from EBITDA?
Gross profit and EBITDA (earnings before interest, tax, depreciation, and amortization) use different formulas. To calculate gross profit, you subtract the cost of goods sold from total revenue. To calculate EBITDA, you start with net profit or income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation, and amortization.
Are EBITDA and gross margin the same thing?
No. EBITDA (earnings before interest, tax, depreciation, and amortization) shows a business’s earnings before interest, taxes, depreciation, and amortization. Gross margin, on the other hand, is the difference between revenue and cost of goods sold, divided by revenue, and is expressed as a percentage.
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