Financial literacy and accountingModule 4, lesson 12 of 19
Operating profit, EBITDA and net profit
The levels of profit from EBITDA to net profit attributable to shareholders, what each includes and leaves out, and which question each one answers.
In this lesson
- Work out EBITDA, operating profit (EBIT), profit before tax and net profit from an income statement.
- Explain what each level of profit includes and leaves out.
- Separate the profit of the core business from other income and exceptional items.
- Explain profit attributable to shareholders and non-controlling interests in consolidated accounts.
- Explain why EBITDA is not the same as cash or profit.
Builds on
- The income statementEvery level of profit in this lesson is read from, or calculated from, the income statement.
On this page
In simple terms
"Profit" is not one number. An income statement passes through several levels of profit on the way from revenue to the bottom line, and each level removes a different kind of cost. Analysts and news reports quote different levels, often without saying which, so it pays to know exactly what each one includes.
From the top:
| Level | What has been subtracted from revenue | The question it answers |
|---|---|---|
| Gross profit | Cost of materials and goods | How much the product itself earns over its direct cost |
| EBITDA | All operating costs except depreciation and amortisation | What the operations earn before the cost of using up long-lived assets |
| Operating profit (EBIT) | All operating costs, including depreciation and amortisation | What the business earns from its operations |
| Profit before tax | Interest, with other income and exceptional items added or subtracted | What the company earned in total, before tax |
| Net profit | Tax as well | What belongs to the shareholders |
EBITDA stands for earnings before interest, tax, depreciation and amortisation; EBIT for earnings before interest and tax. Indian income statements usually print profit before tax and net profit, but not EBITDA or operating profit, so you work those out yourself.
Worked example
Worked example: Kaveri Pumps, all levels of profit
The made-up company from the income statement lesson (₹ crore):
| Revenue from operations | 1,200 |
|---|---|
| Cost of materials | −660 |
| Gross profit | 540 |
| Employee benefits | −150 |
| Other expenses | −170 |
| EBITDA | 220 |
| Depreciation and amortisation | −50 |
| Operating profit (EBIT) | 170 |
| Other income | 20 |
| Finance costs | −30 |
| Profit before exceptional items and tax | 160 |
| Exceptional item: gain on selling land | 40 |
| Profit before tax | 200 |
| Tax | −50 |
| Net profit | 150 |
The pump business itself earned ₹170 crore of operating profit. Net profit of ₹150 crore looks close to that, but only because a one-off ₹40 crore land sale roughly offset interest and tax. Next year, without the land sale, net profit would be much lower even if the business performed exactly the same.
Other income and exceptional items
Other income includes interest on cash, dividends from investments, rent and similar income outside the main business. It is real, but it says nothing about how well the core business is doing, and it can swing with interest rates.
Exceptional items are unusual gains or losses, such as selling property, restructuring costs or large impairments. Companies show them separately so readers can see the profit of the regular business. Watch for companies whose "exceptional" items appear almost every year: at that point they are part of the business.
Tax and the effective tax rate
The effective tax rate is tax expense divided by profit before tax: 50 ÷ 200 = 25% for Kaveri. It can differ from the headline tax rate because of tax incentives, losses carried forward, income taxed at different rates and deferred tax. A sudden fall in the effective rate can lift net profit without the business improving.
Profit attributable to owners
Consolidated accounts include subsidiaries the parent controls but may not fully own. If the parent owns 80% of a subsidiary, 20% of that subsidiary's profit belongs to its other shareholders, called the non-controlling interest (or minority interest).
Worked example: A group with a partly owned subsidiary
A made-up group reports consolidated net profit of ₹90 crore, of which ₹12 crore belongs to minority shareholders in its subsidiaries.
| Consolidated net profit | ₹90 crore |
|---|---|
| Attributable to non-controlling interests | −₹12 crore |
| Attributable to owners of the parent | ₹78 crore |
A shareholder in the parent company has a claim only on the ₹78 crore. Earnings per share and valuation measures for the parent should use this figure.
EBITDA: useful, and easy to misuse
EBITDA is popular because it compares the operating earnings of companies with different amounts of debt (interest is excluded) and different ages of assets (depreciation is excluded). It is the starting point for measures such as EV/EBITDA used in valuation.
But it leaves out real costs. A business must pay interest on its debt, pay tax, and replace the equipment it wears out. Companies that promote "adjusted EBITDA" while their net profit is small or negative are asking you to ignore exactly the costs that matter. EBITDA is also not cash: it ignores working capital and capital spending, which the cash flow statement shows.
Why it matters
Headlines quote whichever profit number sounds best. "EBITDA up 20%" and "net profit down 30%" can both be true in the same quarter. Knowing the levels lets you see where a change came from: better pricing (gross profit), cost control (EBITDA), heavier investment (depreciation), more debt (interest), one-offs (exceptional items) or tax.
Limitations
- Different companies classify items differently, for example what counts as exceptional, so compare definitions before comparing numbers.
- EBITDA and operating profit are not defined in the accounting standards, so companies' own calculations of them can differ.
- A single year's profit at any level says little; look at several years and at the cash flow statement too.
Common mistakes
- Treating EBITDA as profit or as cash. It excludes interest, tax, depreciation, working capital and capital spending.
- Including exceptional gains in "normal" profit.
- Using consolidated net profit for a parent's shareholders when part of it belongs to minority shareholders.
- Ignoring a falling tax rate that lifts net profit without the business improving.
Try it yourself
- From any company's consolidated statement of profit and loss, calculate EBITDA and operating profit for the last two years.
- Note other income, exceptional items and the effective tax rate. How much of the change in net profit came from each?
- Find "profit attributable to owners of the company" and compare it with total net profit.
Key takeaways
- EBITDA is profit before interest, tax, depreciation and amortisation. It is a rough view of operating earnings before the cost of assets, not a measure of cash.
- Operating profit (EBIT) subtracts depreciation and amortisation too, and shows what the business itself earns.
- Profit before tax adds other income and subtracts interest and exceptional items; net profit is what is left after tax.
- In consolidated accounts, part of net profit belongs to minority shareholders in subsidiaries; investors in the parent should use profit attributable to owners.
- Each level answers a different question, so use the one that fits the question you are asking.
Check your understanding
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Terms used in this lesson
- EBITDA
- Earnings before interest, tax, depreciation and amortisation, a rough measure of the profit from a company's operations.
- Operating profit
- Profit from a company's operations after all operating costs, including depreciation, but before interest, other income and tax.
- Net profit
- What is left of revenue after every expense, including interest and tax. It belongs to the shareholders.
- Non-controlling interest
- The share of a partly owned subsidiary's profit and net assets that belongs to its other shareholders, not to the parent company.
- Effective tax rate
- A company's tax expense divided by its profit before tax, which can differ from the headline tax rate.
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This lesson is general education, not investment advice. Examples use made-up or clearly dated figures to explain ideas; they are not recommendations. Read the disclaimer.