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EBITDA and revenue are two key metrics of a company’s health and financial performance. Revenue is the amount of money a company brings in from its operations, while EBITDA is the revenue that’s left after subtracting the cost of goods sold and some other operational expenses.
Analyzing revenue and EBITDA serves different purposes for a small business. Read on to learn why each metric is important, the differences between revenue and EBITDA, and how to calculate these numbers.
Key Points
• EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization, and it’s a measurement of a company’s operating profitability.
• Revenue is listed on the top line of an income statement, while EBITDA doesn’t have to appear on an income statement at all.
• When a company is considering whether to look at revenue vs. EBITDA, the former indicates how much money the company is taking in, while the latter helps it assess the organization’s operational efficiency.
• EBITDA is also useful for comparing companies with different capital structures.
• EBITDA-to-revenue ratio shows cash generated per dollar of sales revenue, with 10% or higher considered good in many industries.
What Is EBITDA?
EBITDA is a measure of profitability that stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. In other words, it’s the earnings that a business has generated prior to any debt interest expenses, tax payments, and depreciation/amortization costs of the business.
While interest, taxes, depreciation, and amortization are expenses that get considered in other financial metrics, EBITDA doesn’t factor these values in because they are outside management’s operational control. Since EBITDA adds these values back to net income (which is gross business income minus all business expenses), many analysts believe that EBITA is a better way to measure how well a business is run.
It’s not required to include EBITDA in an income statement, but if it were, it would appear a few lines below the revenue line item. A business’s EBITDA number will always be smaller than its revenue figure, as certain operating expenses are deducted from revenue to arrive at it.
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What EBITDA Does
EBITDA is often used by analysts to assess a business’s financial performance and operational efficiency. Because EBITDA adds back interest, taxes, depreciation, and amortization (expenses that don’t directly reflect a company’s decisions) to a company’s net income, it shines a light on a business’s ability to generate cash flow from its operations.
Depreciation and amortization, for example, are non-cash expenses – they’re considered costs on an income statement but do not require the actual outlay of money. While interest and taxes do require payment in cash, they are non-operating expenses not directly affected by the business’s primary activities.
EBITDA may be calculated by investors or when you’re applying for a small business loan to estimate how well your company will be able to pay its bills and maintain or increase net income.
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How EBITDA Is Calculated
One of the most common ways to calculate EBITDA is to start with net income (the bottom line of the income statement), and then add back the entries for taxes, interest, depreciation and amortization.
EBITDA Formula
Net income + Taxes Owed + Interest + Depreciation + Amortization = EBITDA
An alternative way to calculate EBITDA is to start with operating income. Operating income is also referred to as operating profit or EBIT (Earnings Before Interest and Taxes). It’s the amount of revenue left after deducting the direct and indirect operating costs from sales revenue. If you add depreciation and amortization to operating income, you get EBITDA.
Operating Income + Depreciation + Amortization = EBITDA
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Why Businesses Use EBITDA
Although EBITDA does not fall under Generally Accepted Accounting Principles (GAAP), it’s frequently used by companies seeking to compare their EBITDA with the standard in their field to see if they should work on improving business performance. It’s a relatively intuitive metric and easy to calculate, and it’s particularly useful for businesses that take on a lot of debt for investments or infrastructure.
Lenders may want to see the EBITDA of a company to get a sense of whether it will be able to make good on its debts, while investors use it to evaluate a company’s value.
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What Is Revenue?
Revenue (also referred to as sales or income) consists of all income generated by a business’s core activities before expenses are taken out. It generally includes both paid and unpaid invoices. On an income statement, revenue is listed on the top line, which is why accountants simply refer to it as the “top line.” (Some companies may also use a metric called “net revenue,” which subtracts any sales-related adjustments such as discounts and returns from revenue, but it’s not recognized under GAAP.)
Revenue can come from several different places, including:
• Product sales
• Fees charged for services
• Rent
• Commissions
• Interest on money loaned
Revenue is typically reported quarterly and annually. Annual business revenue is how much income a company generates during one year.
While revenue is vital to a company’s longevity and financial health, it doesn’t show the complete picture. Because it’s a top line item, it doesn’t take into account how much the company had to spend to make that money.
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What Revenue Does
Revenue is a measurement of all sales activity and can indicate how well a business is doing in the market. Revenue is also what allows a business to pay its employees, purchase inventory, pay suppliers, invest in research and development, sustain itself, and grow.
Revenue can also be used as a measure of how sales are increasing or decreasing over time. If revenue is increasing from one quarter or year to the next, then the company is seeing success with its initiatives. Declining revenues year over year means that a company is shrinking or faltering.
Businesses generally aim to increase their revenue and lower their expenses in order to maximize profit.
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How Revenue Is Calculated
Revenue is the sum of income from the sale of goods and services. Money received from one-time events and investment income are usually listed separately.
The formula for total revenue is:
Price x Quantity Sold = Total Revenue
Revenue does not take any expenses into account.
Types of Revenue (Operating vs. Non-Operating)
Companies may find it useful to differentiate between operating vs. non-operating revenue. Operating revenue is generated by sales of the company’s core products. Non-operating revenue is the result of one-time events, like being awarded cash in a lawsuit or selling a large asset, such as a building. It’s much less predictable than operating revenue. The two are usually shown separately on an income statement.
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Comparing EBITDA vs. Revenue
While EBITDA and revenue are related financial metrics, they have some distinct differences. Here’s a look at how they compare.
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Similarities Between EBITDA vs. Revenue
Both EBITDA and revenue are measures of a company’s financial performance and can be important predictors of a business’s future prospects.
The more revenue a company generates, for instance, the more money it has to work with to pay down expenses and generate a profit. (This is also true when we look at net revenue vs. EBITDA.) A strong EBITDA number, on the other hand, indicates that a company will be able to pay its bills and maintain or increase net income. It also suggests that a company is being run well.
Investors will often look at both revenue and EBITDA to gauge the health of a business.
Differences Between EBITDA vs. Revenue
The main difference between revenue and EBITDA is that revenue measures sales activity, while EBITDA measures how profitable the business is. (Again, this is also true for net revenue vs. EBITDA.)
Revenue is calculated by adding up income from all business operations, whereas EBITDA takes that revenue and then subtracts expenses in order to measure profit.
Another key difference is that the Financial Accounting Standards Board (FASB), which establishes the rules and standards of GAAP, requires revenue to be reported on the income statement, but not EBITDA.
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When to Use EBITDA vs. Revenue
Both these metrics can be useful, but it’s important to use them appropriately, based on what they actually measure.
Revenue is particularly useful for measuring growth. By tracking it over time, you can see if your company is expanding or contracting and you can compare your company’s revenue against that of others in your industry to see where it falls in the range of similar companies.
EBITDA can help you (as well as lenders and investors) understand how efficiently your company is operating. By eliminating financial factors over which you have no control, it focuses on how well your company is doing. It can also be used to compare different companies.
Pros and Cons of EBITDA
| Pros of EBITDA | Cons of EBITDA |
|---|---|
| Shows how well ongoing operations create cash flow | Doesn’t account for all expenses |
| A better measure of a company’s operational efficiency than net profit | Some aspects of debt are overlooked |
| Allows you to compare operational performances across companies with different capital structures | Can be used to mislead investors about a company’s earnings |
Where EBITDA Shines
Many analysts, business owners, and investors prefer EBITDA over other business metrics because it specifically measures the operational profitability of a firm.
When calculating EBITDA, the only costs subtracted from revenue are ones that are directly linked to the company’s operations (such as rent, salaries, marketing, and research). Capital structure decisions, which are reflected in depreciation, amortization, and debt expenses, aren’t included. As a result, it gives analysts a way to more accurately compare performance between companies with different capital structures.
Limitations of EBITDA
However, EBITDA doesn’t reflect a business’s actual net earnings (gross business income minus all business expenses). Indeed, some companies can report a seemingly strong EBITDA while stating negative profits on the bottom line.
EBITDA can sometimes be misleading because costs associated with debt aren’t included. This means that you may overlook any unhealthy debt decisions made by the company if you review only the EBITDA.
EBITDA also excludes depreciation and amortization expenses. However, machines, tools, and other assets lose their value over time, and copyrights and patents expire. EBITDA fails to account for these costs.
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How Investors Use Revenue and EBITDA in Valuation
When investors are determining the value of a company, they may use the company’s revenue or EBITDA metrics in conjunction with valuation multiples (financial ratios that compare the value of a company to different metrics).
For companies that are young and high-growth, have negative or uneven earnings, or prioritize long-term growth over immediate profitability, investors may look at revenue, in relation to revenue valuation multiples, to assess the company’s value. For companies that are more established, profitable, and in traditional industries, investors are more likely to use EBITDA and EBITDA valuation multiples in their evaluations.
The Takeaway
Both revenue and EBITDA are used to analyze and evaluate how well a company is performing. Revenue is the key top line on a financial statement, showing income generated by the company’s sales activities before expenses are deducted. EBITDA starts at the bottom of the income statement with net income, then adds back expenses (like interest on debt) that aren’t directly related to a company’s operations.
EBITDA can be helpful for seeing how a business performs from year to year, but it does not reflect a company’s real income. That’s why if you’re exploring business loans or looking to attract an investor, EBITDA will likely be one of several metrics used to gauge the health of your business.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
Are EBITDA and revenue the same?
No. Revenue measures sales while EBITDA (earnings before interest, taxes, depreciation, and amortization) measures the profitability of a business.
Can EBITDA be higher than revenue?
No. EBITDA (earnings before interest, taxes, depreciation, and amortization) will always be lower than revenue because it tells you how much revenue is left after subtracting the cost of goods sold and some other operational expenses.
What is considered a good EBITDA-to-revenue ratio?
EBITDA-to-revenue ratio, also known as EBITDA margin, shows how much cash a company generates for each dollar of sales revenue, before accounting for interest, taxes, amortization, and depreciation. A “good” EBITDA margin depends on the industry, but, generally speaking, an EBITDA margin of 10% or higher is considered good.
Why is EBITDA better than net income?
EBITDA will be higher than net income because it’s the net income plus interest, taxes, amortization, and depreciation. While EBITDA is not necessarily “better” than net income, it is a better indicator of whether or not the business is functioning well.
Is EBITDA a profit or loss?
EBITDA reflects the core offering profitability of a business. It shows earnings before interest, taxes, depreciation, and amortization.
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