The earnings of a company before interest, taxes, and depreciation are deducted from the net income
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What is EBITA?
EBITA is an acronym that refers to the earnings of a company before interest, tax, and amortization expenses are deducted. Investors use EBITA as an indicator to measure the profitability and efficiency of a company and compare it with similar companies.
EBITA includes the cost of capital assets (depreciation) but excludes the associated financing costs as well as amortization of any intangible assets; hence it can more accurately present a company’s performance. It can be compared with EBIT (earnings before interest and taxes) and EBITDA (earnings before interest, taxes, depreciation, and amortization) to better understand a company’s earnings.
Summary
- EBITA is the earnings of a company before interest, taxes, and amortization are deducted from the net income.
- The metric shows the company’s true performance by excluding the financing costs and reflects the profitability of the company’s operations.
- EBITA allows investors to make an easy comparison of different companies operating in the same business.
Significance of EBITA
Income and expenses from investments, taxes, loan interests, and various types of depreciation, considered to determine the net profit of a company, often do not directly relate to a company’s success. The net income reflects the overall profitability of a company, whereas EBITA reflects the operating profitability.
Therefore, the true performance of a company’s operations can be determined when the effects associated with taxes, interest, and amortization are removed. Since the effect of such items is excluded in EBITA, investors consider it an important measure to determine a company’s true earnings.
EBITA value can be either positive or negative. A positive EBITA value indicates the efficiency of the operation of a company, showing the cash flow amount available with the company to pay dividends or reinvest in business growth. A negative EBIT is not acceptable as it indicates that the company may be facing troubles in managing the cash flows or making profits.
Furthermore, the EBITA figure helps in comparing the operating successes of various companies. Lenders can use EBITA figures to determine a company’s creditworthiness as EBITA describes a company’s real earnings, which, in turn, reflects the company’s capability to settle its debts.
A high EBITA figure is important for a business; however, it should also lead to a high net income figure as well. A company may be taking loans to grow its business, which may decrease its net income in the coming years. Hence, tracking the company’s increasing EBITA may provide a glimpse of the future after the debts are paid.
How to Calculate EBITA
EBITA can be calculated by the following methods:
Direct method
In the direct method, the cost of goods sold (COGS) and operating expenses less amortization are subtracted from the company’s total revenue. Thus,
EBITA = Total Revenue – COGS – (Operating Expenses – Amortization)
Companies sometimes may not provide a breakdown of either the operating expenses or the cost of goods sold in the financial statements. In such cases, a company’s EBITA can be calculated using the indirect method.
Indirect method
In the indirect method, the interest, taxes, and amortization are added back to the net income, giving the EBITA value.
EBITA = Net income + Interest + Taxes + Amortization
Since all the above items are available on the income statement, such a method of calculating EBITA is straightforward.
Practical Example
Suppose the income statement of Company X for 2018 and 2019 shows the following sections:
The company’s total revenue in 2018 was $1,500,000, and the net income was $1,394,000. The company wanted to increase the revenue and hence took a loan to buy inventory. The company’s revenue was reported as $1,700,000 at the end of 2019. However, the net profit of the company reduced to $1,359,000 in 2019.
The higher sales with smaller profit can be explained using EBITA. When the company’s net income is adjusted for taxes, interest, and amortization expenses, the profit instead increases.
EBITA for 2018 = $1,394,000 + $6,000 + $35,000 + $0 = $1,435,000
EBITA for 2019 = $1,359,000 + $6,000 + $90,000 + $105,000 = $1,560,000
The above calculation shows that even though the company’s net income decreased by $35,000, the earnings before interest taxes and amortization for the company increased by $125,000 in 2019.
Related Readings
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