Last Updated on March 30, 2023
EBITA is an acronym for Earnings Before Interest, Taxes, and Amortization. It refers to a company’s gross earnings before deducting interest, taxes, and amortization expenses. EBITA is a financial indicator widely used to measure a company’s efficiency and profitability.
Components of EBITA
1. Earnings
Earnings simply refer to what a business brings in over a specified period of time. It’s generally expressed in real monetary value and often excludes any intrinsic assets that a company may lay claim to.
To arrive at your company’s total earnings, you subtract the operating expenses from the total revenue.
Illustration;
A company generates total annual revenue of $100 million from operating expenses of $20 million.
The earnings would be calculated at;
> Total Revenue – Total Operating Expenses.
> $100 million – $20 million = $80 million.
If Earnings have a positive value, it implies that the business made profits over the given duration. On the flip side, a negative value indicates losses.
2. Interest
The term ‘interest’ usually represents an amount of money earned over a given period of time. But within the context of EBITA, interest refers to the amount spent in servicing debt. Therefore, it’s an expense and not a profit.
Illustration;
Your business secures a loan to the tune of $200 million at a simple interest rate of 5% p.a, payable within one year.
In an ideal, interest-free situation, you’d incur no expenses if you serviced this loan within the specified duration.
But as interest is involved, your total expenses would be;
$200, 000, 000 X 5/100 = $10, 000, 000
Since the interest rate is applied per annum, the actual annual expenses you’d incur is calculated as;
$10,000,000/12 = $833,333.33
Therefore, your total expenses servicing a $200 million debt would be $833,333.33, and that’s your interest payment.
Interest is generally excluded from EBITA because it depends on a company’s capital structure and the prevailing interest rates.
3. Taxes
Taxes are the expenses resulting from the tax rates imposed by the municipality, city, or country where your company is based. In EBITA, a company’s earnings are calculated before taxation.
Taxes and Interests oftentimes share a Cause-Effect relationship. For instance, certain interest payments may be tax-deductible. The implication here is that a business ends up spending more money servicing debt than it would if the interest payments were tax-free.
Similarly, tax laws are usually more lenient towards certain companies, particularly non-profit organizations. For instance, subsection 501 (c) of the Internal Revenue Service (IRS) tax code exempts non-profit organizations from federal income taxes. So, even if a non-profit organization ends up earning some profit (which occasionally happens in many organizations), they aren’t required to remit any income taxes.
4. Amortization
The last element of EBITA refers to the non-cash expenses related to the eventual expiration of intangible assets over time. Examples of such assets include patents.
If these assets were tangible, then this expense would be known as Depreciation. In EBITA, amortization is added back to the operating profit.
Much like Depreciation, Amortization is calculated by subtracting an asset’s residual value (salvage value) from the recorded cost, then dividing the difference by the asset’s useful life.
Illustration;
A patent costs $1 million at the time of its lease. After a 5-year lease period, the patent’s salvage value is now estimated to be $200,000.
To calculate its Amortization, you subtract the salvage value ($200,000) from the recorded cost ($1,000,000).
> $1,000,000 – $200, 000 = $800,000.
You then divide the difference by the patent’s useful life, i.e. $800,000/5 = $160,000
NB: Most EBITA calculations ignore Amortization, usually assigning it the value of ZERO.
Common Metrics Similar To EBITA
- EBITDA – Earnings before interest, taxes, depreciation, and amortization.
- EBITD/PBDIT – Earnings before interest, taxes, and depreciation/Profit before depreciation, interest, and taxes.
- EBIDAX – Earnings before interest, depreciation, amortization and exploration.
- EBIDTAC – Earnings before interest, taxes, depreciation, amortization, and coronavirus.
- EBITDAR – Earnings before interest, taxes, depreciation, amortization, and restructuring or rent costs.
- OIBDA – Operating income before depreciation and amortization.
Calculating EBITA
Now that you’re acquainted with the different EBITA elements, it shouldn’t be difficult to calculate EBITA.
EBITA is generally calculated by first adding a company’s expenses on interest payments, total taxation, and amortization. You then add the sum to the company’s total earnings.
The formula can better be expressed as follows;
EBITA = Earnings + (Interest + Taxation + Amortization)
Illustration;
A company known as ABC Inc. generated revenue of $100 million from operating expenses of $20 million during one of its financial years.
The following events also happened over the same period;
• ABC Inc. secured a loan worth $10 million at an annual interest rate of 8%.
• A sales tax worth $500,000 was levied on the company’s goods and services
• A patent previously owned by ABC expired after an 8-year lease period. The patent’s original cost was $2 million and at the time of expiry, it was valued at $100,000
How do you calculate ABC’s EBITA over this particular financial year?
First, you’ll need to restate EBITA formula, which is Earnings + (Interest + Taxation + Amortization)
You then calculate the quantity of the individual elements and find their sum.
a) Earnings: Total Revenue – Total Operation Expenses, which is $100,000,000 – $20,000,000 = $80,000,000
b) Interest: 10,000,000 x 8/12 x 1/12 = $66,666.66
c) Taxation: You simply add the total amount of taxes levied over this period, which is $500,000
d) Amortization: ($2,000,000 – $100,000)/8 = $237,500
e) Now, calculate EBITA by adding the totals of earnings, interest, taxation, and amortization; $80,000,000 + 66,666.66 + $500,000 + 237,500 = $80, 804, 166.66
The following are additional formulae you can use to calculate EBITA;
EBITA = Gross Revenue – Cost of Goods Sold – (Operating Expenses +Amortization).
EBIZA = Net Income + Taxes + Interest + Amortization
Benefits of EBITA
- EBITA offers numerous benefits to companies and organizations. Most notably, it highlights a company’s operational profitability. Using EBITA, you can gauge how much your business earned from a given operational cost.
Entrepreneurs can also use EBITA to measure the operating performance of their business. That’s because the formula eliminates unhelpful variables, such as capital structure.
The following are other notable benefits of EBITA;
- EBITA is fairly easy to grasp and widely applied by various business stakeholders, including buyers and investors.
- The metric is reliable as it allows investors to track their baseline profitability.
- It’s a useful tool for gauging the efficiency of a company’s day-to-day operational potential.
- It highlights the cash flows generated by a business directly from its operations.
Drawbacks of EBITA
- The most glaring drawback of EBITA is that it’s not an officially recognized metric by the International Financial Reporting Standards (IFRS) or the US Generally Accepted Accounting Principles (GAAP). So, corporations that prefer to play by the book may express some reservations about using the EBITA metric. In fact, renowned investors like Warren Buffet have expressed open disdain for EBITDA, which is a close variant of EBITA.
Another drawback with EBITA is that it focuses only on baseline profits and doesn’t factor in capital expenditure. The metric excludes potential problems in a capital structure, which may affect its overall efficiency.
Other drawbacks to EBITA include;
- Most EBITA calculations ignore amortization, arguing that it can always be taken care of at a later date.
- EBITA doesn’t state if a company is overleveraged, which might raise questions about the company’s creditworthiness.
- The metric doesn’t take into consideration the process of asset liquidation.
Final Word
EBITA may not be recognized by the IFRS or the GAAP. But the metric is highly useful in tracking a company’s baseline profitability.
If you’re only interested in assessing your business’ performance based on day-to-day operational procedures, then you might want to consider EBITA. What’s more, EBITA is incredibly easy to grasp compared to similar metrics.
