Operating Income, EBIT and EBITDA Explained

Operating Income, EBIT and EBITDA

Operating income and EBIT measure profit from the core business; EBITDA adds back depreciation and amortisation. Learn the formulas, uses and EBITDA's flaws.

Intermediate3 min readUpdated 3 Oct 2026

Lesson 6 of 45

Operating income shows how much profit a company makes from its core business, after paying for production, sales, administration and research, but before interest and taxes. EBIT (earnings before interest and taxes) is closely related, and EBITDA (earnings before interest, taxes, depreciation and amortisation) goes further by adding back non cash charges. These measures let traders compare businesses with different debt levels and tax situations, and they underpin popular valuation ratios such as EV/EBITDA.

Definitions#

Measure	Formula	What it shows
Operating income	Revenue minus COGS minus operating expenses	Profit from core operations
EBIT	Net income + interest + taxes (often similar to operating income)	Profit before financing and tax
EBITDA	EBIT + depreciation + amortisation	A rough proxy for operating cash earnings
Adjusted EBITDA	EBITDA excluding items management considers unusual	Company specific; often flattering

Operating income and EBIT can differ when a company has non operating income or expenses, such as gains on investments.

Worked example#

From revenue to EBITDA

Line	$ millions
Revenue	2,000
COGS	(1,200)
Operating expenses (excluding D&A)	(400)
Depreciation and amortisation	(150)
Operating income (EBIT)	250
Add back D&A	150
EBITDA	400

EBIT margin: 12.5%. EBITDA margin: 20%. If the company's capital expenditures are $180 million a year, EBITDA minus capex is $220 million, a better sense of cash earnings than EBITDA alone. See Capex, Depreciation and Amortization.

Why analysts use EBITDA#

Compares companies with different debt levels, since interest is excluded.
Removes differences in depreciation policies and the effects of past acquisitions (amortisation).
Used in debt covenants and leverage ratios, such as net debt / EBITDA.
Base for EV/EBITDA valuation, popular in mergers and private equity. See EV/EBITDA and EV/Sales.

Criticisms of EBITDA#

Warren Buffett and Charlie Munger were famously harsh critics of EBITDA, arguing that it ignores real costs. The main objections:

Depreciation is a real cost: equipment wears out and must be replaced. A capital heavy business with high EBITDA can still generate little cash.
Ignores working capital needs. See Working Capital.
Ignores interest and taxes, which must be paid.
Adjusted EBITDA can exclude recurring costs such as stock based compensation and "one off" restructuring charges that happen every year.

Operating margin and leverage#

operating margin = operating income / revenue

Companies with high fixed costs see operating income grow faster than revenue when sales rise, and fall faster when sales drop. This is operating leverage. See Operating and Financial Leverage and Revenue Growth and Margin Analysis.

Using these measures well#

Start with operating income for profitability from the core business.
Use EBITDA for comparisons and leverage ratios, but always subtract capex.
Check the reconciliation from GAAP net income to adjusted EBITDA in earnings releases.
Compare cash flow from operations with EBITDA to test quality. See Earnings Quality and Cash Conversion.

Frequently asked questions#

What is the difference between EBIT and EBITDA?#

EBIT is earnings before interest and taxes; EBITDA also adds back depreciation and amortisation, which are non cash charges.

Why is EBITDA criticised?#

Because it ignores real costs such as replacing equipment, working capital needs, interest and taxes, and adjusted versions can exclude recurring expenses.

What is operating income?#

Revenue minus the cost of goods sold and operating expenses, showing profit from the core business before interest and taxes.

Next, reach the bottom line in Net Income and EPS.

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