Owning a business is all about metrics, budgets, and planning. Even the best parts of owning a company, like marketing, ad campaigns, or earning more customer loyalty, are still about the numbers. One metric that will tell you the full story of how profitable you are is EBITA.
EBITA means earnings before interest, taxes and amortization. In other words, it shows you how much your business made before factoring in interest, taxes and amortization. This gives you a more accurate view of your company’s performance over time. Why's that?
Interest and taxes can change over the years with new policies coming into play, so factoring those things into your profitability may skew numbers.
EBITA, however, allows you to see if your operations have been turning a profit year over year. It’s one way to see how efficient you are.
Want to learn more about why this number is so useful? And how to calculate it? We’ll go over all that and more, so keep reading!
Why Should a Business Use EBITA?
The top reasons a business might use EBITA include:
- Gauge whether you need to make operational changes: EBITA shows you how much you're making off your operations, and if you discover they aren't making as much money as you'd like, you can consider things like upgrading equipment, providing more training to staff, increasing prices, or something else.
- Figure out if you can reinvest in your company: Since EBITA is a better gauge of actual cash flow, it can be used to figure out how much money you have to reinvest in your business or pay dividends. In short, it's one indicator of whether a company can grow over time.
- Determine if you should merge with or buy another company: This metric can give both businesses an idea of standing profitability over a set period of time and can help them figure out if a business is a strong candidate for a merger or to get bought out. In other words, if you’re wondering, “Is it really worth it to buy this company?” EBITA can help answer that.
- Attract investors: Investors will most likely look at EBITA when trying to figure out the value of a company (and if they should back it). If this metric is higher than another business’s, then that’s a sign your operations are efficient. If it’s lower than another company’s, then they might have a leg up on how they run their business and sell their product–and an investor might choose them.
Your accounting team will likely apply EBITA to the last twelve months of financial results to represent the total amount of earnings before adjustments. However, this metric can be measured over any given period (such as over a quarter, year, month, etc.).
A Word of Caution
This is a non-GAAP metric, meaning that it’s not typically used within accounting principles, nor is it recognized by the international financial reporting standards (IFRS). Why? If a company is carrying a lot of debt or manipulating amortization schedules to inflate profits, EBITA can make it look as though a company is doing great when it’s really not. And, when the truth comes out, investors could be in a tough spot.
Even though it does offer some insight into your total cash flow for the period you’ve set, like all metrics it should be used in tandem with others.
How Do You Get EBITA? The Formula Explained
To get this metric, you’ll need to gather financial statements like your income and cash flow statements within the time you’d like to review them.
The easiest formula to use is:
EBITA = Net Income + Interest + Taxes + Amortization
- Net income: Or earnings, tells you how much your company has left over after removing all expenses from your total revenue.
- Interest: Tells the story of how a business pays for each expense. When you calculate interest expense, include interest rates such as loans by banks or third-party lenders.
- Taxes: These are largely location-based because every area has its own laws and regulations around tax expenses and requirements. Tax payments can also vary from one company to another. So, make sure you have this number down.
- Amortization: This is another noncash expense that represents the cost of intangible assets that you gradually write off over their useful life (patents and trademarks are some examples).
But wait, why are there plus signs in the formula when we’re supposed to be taking interest, taxes and amortization out?
Well, it may seem counterintuitive, but in order to see your company’s earnings as if you weren’t paying taxes, interest or amortization, you’ll have to add those things back in. Why is that? Because the formula starts with a company’s net income, which takes out all of your expenses (including interest, taxes, etc.). Some people refer to this formula as the indirect method.
You can also calculate EBITA with this formula:
EBITA = Operating Profit + Amortization
In this method, you find your operating profit by subtracting your operating expenses from your gross profit. This method only takes out amortization, so you’ll have to add it back in to see what your profitability would be without it taken out of your income.
Which Formula Should You Use?
Both formulas are a straightforward way to calculate this metric because everything you need is listed on your income statement. They should both equal the same value.
Example of Calculating EBITA
Imagine you’re a business that wants to know how well it performed last year.
You made $100 million in revenue, but your cost of goods sold (COGS), or how much it takes to make the product plus the labor involved, amounted to $40 million. Your overhead was $20 million. Amortization expenses added up to $10 million, which leaves your operating profit at $30 million.
Your interest added up to $5 million, which leaves your earnings before taxes at $25 million. Add in $4 million in taxes, and that leaves your net income at $21 million.
EBITA = Net Income + Interest + Taxes + Amortization
= $21 million +$5 million + $4 million + $10 million
= $40 million
EBITA = Operating Profit + Amortization
= $30 million + $10 million
= $40 million
What’s a Good EBITA?
When the calculations are completed, you'll get a positive or negative value. But which one is better? Well, this one will seem intuitive, but let’s dive in a little deeper!
Negative Value
A negative value would represent a business that has difficulties operating at a profit. If you have a negative net income or operating profit to start with, you might hope that adding back in all those taxes, interest and amortization you deducted initially might get you up to a positive value.
If it doesn’t, then you can gather that it’s not just the burden of taxes, interest or amortization that is causing you to lose out on profits–it’s something in your company’s operations. That can be a good impetus for changing up how you do things, whether it’s in production or sales.
Positive Value
A positive outcome would convey an efficient corporate finance strategy, so great work! The higher your EBITA, the lower your operating expenses are compared to your overall revenue. This means you’re making more than you’re spending before taxes and interest are added back in.
EBITA vs. EBITDA vs. EBIT
You may come across another acronym called EBITDA (earnings before interest, taxes, depreciation, and amortization), which takes out depreciation from your earnings too. Depreciation is a way to allocate the cost of a tangible asset over its useful life.
In a business that invests heavily in real estate, equipment, and other fixed assets, EBITDA is an important metric to use. That’s because depreciation can take out a large chunk of a company’s income, so to get a better view of their cash flow, they’ll need to ignore depreciation for a moment. EBITDA is a useful metric for manufacturers, utility companies, construction contractors, and other companies that purchase a lot of equipment.
EBITDA = Net Income + Interest + Taxes + Depreciation + Amortization
In the same vein, EBIT (earnings before interest and taxes) doesn’t take out amortization or depreciation. It’s a good calculation for businesses that have smaller expenses and investments, like a consulting company.
EBIT = Net Income + Interest + Taxes
All three types provide a view of a company’s profit or how much they make doing business.
EBITA Margin
It’s always a good practice to calculate other numbers to figure out just exactly how profitable you are. One way to do that is by finding your company’s EBITA margin.
The margin is calculated when you divide the value with another value, like revenue:
EBITA Margin = EBITA/Revenue
Most S&P-500-listed businesses have a margin of 11-14%, so we recommend shooting for 10% or higher if you can.
EBITA Gives You a True Look at the Profitability of a Company
If you’re trying to figure out how profitable your business is or whether you should invest in a company, consider using EBITA (or some other variation of it).
Other metrics, like a company’s net profit, only tell part of the story since they factor in expenses your business can’t control and vary depending on economic and political changes.
EBITA is an easy way to compare cash flow from one quarter to another. And now that you know all there is to know about this metric, all that’s left to do? Get out that income statement and calculator, and go for it!
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