Choosing between EBIT vs. EBITDA for Credit Risk Analysis
The remaining difference between these two concepts is the exclusion of depreciation and amortization charges. See separate articles entitled How to Calculate EBIT and Explaining EBITDA Calculation and Examples of Its Uses for Credit Risk Analysis, for more explanations and examples of their individual uses as credit tools.
The following are significant differences in comparing certain EBIT vs. EBITDA aspects of credit risk analysis, where one excludes depreciation and amortization while the other does not.
Which Projection is More Conservative?
EBIT takes on a more conservative outlook in the measure of cash position over EBITDA, because it does not add back depreciation and amortization charges in estimating the company’s available cash funds. This silently increases the margin of allowance for contingencies related to the business’s capital assets, inasmuch as possible costs of major repairs are adequately provided as depreciation and amortization valuations.
To illustrate, let us compare an EBIT of $72,000 vs. an EBITDA of $94,200. Dividing these two figures for 12 months will result in quotients of $6,000 and $7,850, respectively. These figures represent estimated monthly income that is free to use. If the loan applied for will bind the borrower to pay a monthly amortization of $3,800 per month, the estimated monthly earnings for both concepts could adequately cover the additional loan payment expenses.
However, lenders would prefer a more conservative stance by choosing the EBIT of $6,000 as projected unencumbered funds. Cost of future major repairs will not affect the remaining projected usable funds since depreciation and amortization expenses were already projected as part of operating expenses.
This is quite the opposite of the $7,850 monthly EBITDA, in which major repairs are still liable to eat up the usable funds generated by the business. Under this concept, eliminating depreciation and amortization charges works under the scenario that the company’s major assets will not undergo any breakdowns or repairs during the term of the loan.