What Is EBITA? Definition, Formula And Explanation

EBITA is short for the earnings before interest, taxes and amortization of a company. In other words, EBITA reflects a company’s profitability, making it a way by which you can compare one company with another, either within industries or as part of the same line of business. 

EBITA can offer a more accurate view of a company’s performance over time. It can also help investors select companies they want to invest in while assisting entrepreneurs as they work to assess the profitability of a company. Whether you’re wondering if you should purchase a company or opt for stock instead, EBITA can help you decide which option is best. 

But in order to fully understand EBITA, you’ll need to know about the impact of interest, taxes, depreciation and amortization on earnings. 

Understanding EBITA

EBITA is an expression of net profits or earnings. It does not deduct interest, taxes, depreciation and amortization. This is what distinguishes EBITA from net income. 

EBITA excludes the company’s capital structure and tax situation from its calculations, while net income includes these items. For this reason, EBITA is a more accurate measure of the true earnings power of a company, making it the preferred tool of many when it comes to tracking the profitability of a company. 

However, some investors and financial analysts prefer EBITA, which also adds depreciation to the equation. 

Here is the equation:

EBITA = earnings before taxes + interest expense + amortization expense

The other preferred formula is EBITDA, which is an abbreviation for net income plus taxes, interest expense, depreciation, and amortization. To calculate EBITDA, you will need to use a similar formula, though it is different in that it incorporates depreciation as well.

Here’s how each component affects EBITA and EBITDA in particular. Let’s look individually at earnings, interest, taxes, depreciation and amortization.

Earnings

Earnings, or profit, is what a company makes from sales of goods or services. In the case of EBITA, this is earnings before taxes are paid, or any calculations are made on interest or amortization expenses. For most companies, earnings are one of the most important and most closely studied numbers in their financial statements.

Interest

Interest is the result of money the company has borrowed to fund business activities. Interest depends on a company’s financial structure. Interest is excluded in the EBITA calculation because different businesses have different capital structures. Some may temporarily appear more favorable than others. For this reason, you can more effectively compare the performance of multiple companies by adding interest back to earnings.

Taxes

Taxes vary by the region of business operation. They relate to the relevant tax jurisdiction’s rules and therefore do not accurately reflect a company’s performance compared to similar companies in other jurisdictions. 

Taxes can also depend on corporate tax structures and a company’s ability to take advantage of tax benefits. Despite these potential strategic benefits, most financial analysts prefer to add them back when comparing businesses. 

Depreciation and amortization

A company’s historical investments affect current depreciation and amortization. Depreciation and amortization do not reflect a company’s current performance. For this reason, it is more accurate to compare companies’ performance without taking into account depreciation or amortization.

Depreciation is related to tangible fixed assets deteriorating over time. Companies take depreciation on cars, furniture, computers and other technology, solar panels, and buildings. Amortization expenses are related to intangible assets like patents. These assets have a limited useful life. Both depreciation and amortization require assumptions about useful economic life, salvage value, and which depreciation model a company chooses to use. 

Note that EDITA does not add back depreciation expense, but does include amortization expenses. The EBITDA calculation formula does add in depreciation. 

How to calculate EBITA

Here are the equations that you can use to calculate EBITA and EBITDA:

First, for EBITA, the formula is as follows: 

EBITA = earnings before taxes + interest expense + amortization expense

Examples of EBITA

Let’s say a company’s earnings before taxes are $4,000,000. The interest expense is $1,000,000 while amortization expenses are $150,000. 

Following the above formula, here is the company’s EBITA:

EBITA = $4,000,000 + $1,000,000 + $150,000 = $5,150,000

Examples of EBITDA

Calculating EBITDA for EBITDA accounting is slightly different. 

For EBITDA, the formula is as follows: 

EBITDA = Net Income + Taxes + Interest Expense + Depreciation & Amortization

Examples of EBITDA

Now, imagine a company’s earnings before taxes are $5,000,000. They owe $2,200,000 in taxes with an interest expense of $1,008,000 and amortization valued at $550,000. From there, the depreciation is $1,550,000. 

Following the above formula, here is the company’s EBITA:

EBITDA = $5,000,000 + $2,200,000 + $1,008,000 + $1,550,000 + $550,000 = $10,303,000

How is EBITA used?

EBITA is one of the most important metrics that investors consider when exploring the possibility of investing in a company. Entrepreneurs use EBITA when they assess a company they are thinking about purchasing as well. 

Simply put, EBITA is a means of analyzing a company’s operating profitability. EBITA looks at profit before non-operating, non-core expenses and non-cash expenses. 

If you are considering the idea of making an investment or purchasing a company, start with EBITA or EBITDA. Doing so will ensure that you have an idea of the profits or income level of a company. You can build upon your financial analysis from there. 

What is a good EBITA for a business?

A high EBITA is better than a low EBITA as the former indicates greater cash flow. Calculating EBITDA allows businesses to assess performance levels and compare incomes between comparable companies. 

Generally speaking, an EBITDA value below 10 is considered good or above average. Many businesses will also utilize the EBITDA margin for further analysis. 

The EBITDA margin is EBITDA divided by total revenue. If company X has an EBITDA of $4,000,000 and their total revenue is $40,000,000, then the EBITDA margin is 10% because $40,000,000 divided by $4,000,000 is 0.10.

If company Y has an EBITDA of $4,000,000 and their total revenue is $$45,000,000, then the EBITDA margin is 8.8%. In these two examples, while both companies have the same EBITDA, company X has a higher EBITDA margin. Therefore, it demonstrates greater potential for returns and growth. 

Drawbacks of EBITA

EBITA is a quick way to get an idea of a company’s income levels, but it doesn’t offer the total picture of cash flow and profitability. Criticism of EBITA centers around its lack of a comprehensive financial picture. Let’s explore other cons of EBITA. 

Excludes depreciation 

Warren Buffett objects to EBITA omitting depreciation. As depreciation is a very real expense in their opinion EBITA does not give the whole financial picture. It can even make unprofitable companies appear profitable.

Lacks accuracy 

Likewise, EBITA removes the real expenses that a company spends on capital. In the context of a company that has considerable capital funding or interest payments, EBITA can make it look as though a company has more cash than it actually does to make interest payments. 

Incomprehensive in terms of cash flow 

Ultimately, investors and entrepreneurs will need to look at total cash flow, not just EBITA. While EBITA gives a partial glimpse into the whole picture, it doesn’t provide the entire financial story. Critics of EBITA say that it can be misleading since it is not as comprehensive as looking at cash flow would be. 

Final thoughts on EBITA and EBITDA accounting

EBITA and EBITDA serve roles as important assessment tools for entrepreneurs and investors. The next time you’re left wondering, “What is EBITA?” remember that these concepts simplify ambiguity about profitability and allow professionals to compare companies more accurately. 

As a part of comprehensive financial analysis processes, EBITA and EBITDA are two ways to quickly assess a company’s profitability before looking more deeply into cash flow and financial reports. 

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