Funny Income Statement Terms and Why They Matter

April 2005

We accountants and finance folks like to make up silly acronyms to maintain the mystery and confusion of accounting. By using mysterious terms and acronyms, we can maintain the illusion that we know more than other people and therefore justify our pay. If folks really knew what we were about, we would be out of a job!

OK, that isn’t exactly true. BUT what is true is that finance isn’t rocket science—or else I couldn’t do it and neither could my peers. We are smart, but not that smart!

So this month, we continue our discussion of terms from the income statement. We have been discussing that key financial document for several months now. To catch up or refresh yourself, click here.

Two of the funniest sounding acronyms derived from the income statement are EBIT and EBITDA. EBIT is pronounced eee-bit and EBITDA is pronounced eee-bit-dah. EBITDA is fun to say and makes you sound like Latka on the sitcom Taxi. Is that still on TV? Anyway, back to what you need to know about these terms.

First of all—EBIT

EBIT stands for Earnings Before Interest and Taxes. Let’s look at a relatively detailed income statement for a second. I am going to add a few things to our income statement that I have not mentioned in previous newsletters.

I took the income statement we used in the last newsletters and added a few line items. I broke operating expenses into a few more categories.

In our example here, EBIT would be

Now what the heck is the point of that? Well, EBIT is a more refined version of earnings. It is earnings that managers have some influence over.

Many organizations base their bonuses to managers on EBIT instead of net income. Why? Because front-line or division managers have little to no control over how much the organization pays in taxes or whether the organization operates using loans that they have to pay interest on. Why should managers be punished if Congress changes the tax law and taxes go up by a few percent? They still did their job.

Notice we add back interest and taxes to net income to come up with a more accurate reflection of what internal management actually produced during the year. That is the theory anyway.

What is EBITDA?

EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortization. So it is EBIT refined.

So in our example, EBITDA would be

Again, it could be argued that managers have very little influence over depreciation and amortization. Yes, they may be the ones using the assets, but they have no control over how many years the organization decides to spread the cost over. (If depreciation and amortization are a little fuzzy to you—no worries—that will be the focus of the newsletter next month!)

Some organizations focus on operating income

Many organizations just use operating income to determine the success of their managers. Operating income is simply EBT (earnings before taxes and other weird stuff) but EBT is not very fun to say. OpInc (pronounced op-ink and short for operating income) is! So that is what we accountants call it.

EBIT, EBIDA, and OpInc are just refinements to net income

In essence, what we accountants are doing with EBIT, EBITDA, and Opinc is refining our definition of how profitable an organization is. Instead of looking at the proverbial "bottom line"—net income—we back out a few expenses and sometimes relatively uncontrollable costs.

Your organization may have its own special income statement terminology

EBIT, EBITDA, and OpInc are relatively common terms—but not everyone uses them. It is not unusual for every industry to have its own terms. It isn’t unusual for a company to generate its own fancy acronyms. Often the only way to decipher these things is to ask what the acronym stands for and then ask your accountant to explain it to you.

You don’t want to talk to the accountant, you say? I understand. I didn’t want to talk to myself this morning either.