Defining Operating Profit (aka EBITDA) 💰
EBITDA stands for Earnings Before Interest Taxation Depreciation & Appreciation.
This can also be calculated by:
Revenue – (Direct + Indirect Costs) = EBITDA
In other words we are asking “what did you sell” minus “how much it cost you to supply your goods/services” plus how much it costs to run your business”.
This shows how profitable your operations are including all your core expenses. As profitability is a key determinant of long-term survival, this is an important KPI. The operating profit margin is normally the first port of call for any investor as it shows how well the business is covering your costs. If you can reduce your costs while keeping your revenue constant, the margin will increase.
Read more about direct costs here and read more about profit margins here.
What Does EBITDA Really Mean?
Operating profit is also known as EBITDA. This is where the profit and loss (P&L) makes the necessary accounting adjustments (and some “paper” i.e. not actual cash adjustments) to get to the Net Profit (the bottom of the funnel, often referred to as the bottom line).
Let’s look at each word that makes up “EBITDA” one at a time:
- Earnings
- Before
- Interest: when you take a loan out, you normally pay interest at an agreed % rate
- Taxation: if you turn a profit you will pay corporation and other taxes. The rates are dependent on where you are
- Depreciation: when you buy a physical asset (e.g. a car), its value goes down as it gets used and the reduction in value is recorded
- Amortisation: when you invest in a non-physical asset (e.g. patent) it will lose it’s value over time and the reduction in value is recorded
And now let’s work down to Net Profit:
From EBITDA, we take off Depreciation and Amortisation which gives us:
EBIT (Earnings Before Interest and Taxation)
Next we remove the Interest to get:
EBT (Earning before—you’ve guessed it!—Taxation)
Once we remove the taxation, we get to:
Net Profit and that’s it: the Bottom Line.
What Does This Mean In Practical Terms?
Now that you’ve seen EBITDA explained, how does it apply to your business?
Lucky for you, Numberslides will take you through everything you need to build your revenue and cost forecast and build your very own profit and loss (P&L) statement. With this you can make all sorts of assessments of your business and by comparing P&Ls to previous ones, you can begin to set targets and spot opportunities and challenges. To determine how healthy your P&L is, you should benchmark yourself against the competitors in your market. Numberslides does this for you by comparing your P&L to thousands of companies in similar sectors. It’s important that you understand Operating Profit and EBITDA, but it’s even more important that you apply it at the right time, to truly understand your numbers.
