Gross Profit vs. EBITDA: What’s the Difference?

There are multiple layers to a modern corporation’s profitability. If you’re an analyst or private equity investor considering a stake, you’ll want multiple ways of looking at it. In addition to net profit, two common metrics used to assess a company’s core strengths and weaknesses are gross profit and earnings before interest, taxes, depreciation, and amortization (EBITDA).

Gross profit focuses on a company’s core profitability—that is, total revenue minus the direct cost of goods sold (generally labor and raw materials). It’s a good gauge of how efficiently a company manages its production costs.

EBITDA zooms out a bit, offering a measure of a company’s ability to generate cash by removing non-cash expenses (depreciation and amortization) from its operating profit, which itself measures profitability by capturing total revenue minus all business costs except interest and taxes (EBIT).

Understanding Gross Profit

Gross Profit: Definition and Calculation

Gross profit measures a company’s efficiency at generating a profit by subtracting only the direct costs of producing its goods or services—such as labor and raw materials—from its revenue.

Formula for Gross Profit

$text{Gross Profit}=text{Revenue}-text{Cost of Goods Sold}$Gross Profit=Revenue−Cost of Goods Sold

Gross profit, also known as gross income, helps assess cost efficiency, pricing power, and production efficiency. A higher gross profit suggests strong cost control or pricing power, while a declining figure may signal rising expenses or inefficiencies. Although it is useful for comparing profitability over time or against competitors, it doesn’t account for overhead, taxes, or financing costs—all key elements of most companies’ true profitability.

Components of Gross Profit

Gross profit is derived from two components: revenue and cost of goods sold (COGS).

• Revenue: This is the total income from sales before expenses. It’s driven by sales volume, pricing strategy and product mix. Maximizing revenue while keeping costs in check shows strong market positioning. However, if growth comes with increasing expenses, it may be the result of inefficiencies in production or supply chain management.
• COGS: Cost of goods, also known as cost of sales, includes all direct costs of production, such as raw materials, direct labor, and manufacturing overheads. To reduce COGS, companies source materials efficiently, optimize labor, and implement cost control strategies such as automation and lean manufacturing.

Importance in Analyzing a Company

Gross profit helps indicate a company’s financial health, cost efficiency, and management effectiveness. It measures how well a business controls the cost of raw materials, labor, and production. A higher gross profit signals strong pricing power and operational efficiency.

Also, gross profit is the backbone for other profitability metrics, helping analysts and investors assess scalability, sustainability, and industry competitiveness, whether it be in manufacturing, retail, or technology.

Understanding EBITDA

EBITDA: Definition and Calculation

EBITDA is another way of looking at a company’s operating income—just stripping out the non-cash expenses of depreciation and amortization.

Formula for EBITDA

$EBITDA=OI + Depreciation + Amortization$EBITDA=OI+Depreciation+Amortization

where:

OI = Operating Income

EBITDA helps analysts and investors compare companies across industries, particularly in capital-intensive sectors where depreciation can distort earnings. However, even though EBITDA is a useful approximation of cash flow potential, it does not account for capital expenditures or working capital changes.

Components of EBITDA

The components of EBITDA are: operating income, interest expenses, taxes, depreciation and amortization.

• OI: OI, also know as EBIT, is a company’s profit from core operations before deducting interest and taxes. A higher OI signals strong operational efficiency and the ability to cover fixed and variable costs.
• Interest: Excluding interest gives better comparisons between companies although a company with a high EBITDA but heavy interest payments may signal an excessive debt risk.
• Taxes: Given that taxes vary by region and other factors, excluding them helps when comparing different companies. A high EBITDA with low taxes may indicate effective tax planning.
• Depreciation: This is a non-cash expense that illustrates the gradual loss in value of tangible assets such as machinery and buildings. While it can lower net income in capital-intensive industries, removing it helps provide a clearer picture of cash-generating potential and capital efficiency across companies.
• Amortization: This is another non-cash expense that reflects the gradual reduction in value of intangible assets like patents, trademarks, and good will. Since it doesn’t impact cash flow, removing it allows for better comparisons between companies with different levels of intangible assets.

Importance in Financial Analysis

EBITDA is handy for comparing profitability across companies and industries because it strips out financing, taxes, and non-cash accounting expenses, providing analysts and investors with a clearer view of core operating performance.

The metric is widely used in valuations and mergers and acquisitions (M&A), helping to assess a company’s earnings potential and cash flow generation.

Differences Between Gross Profit and EBITDA

Use Cases and Contexts

There are several scenarios where gross profit will be the metric to use and others where EBITDA is preferred. The table below provides an overview.