# EBITA

## What is 'EBITA'

EBITA is an acronym for earnings before interest, taxes and amortization. To calculate a company's EBITA, start with its earnings before tax (EBT), which can be found on the income statement, and add interest and amortization expenses back in. EBITA is a variation of the more commonly used EBITDA, which deducts depreciation expenses. Both are used to gauge a company's operating profitability, that is, the earnings it generates in the normal course of doing business, ignoring capital expenditures and financing costs. Both measures are sometimes considered indications of cash flow.

EBITA = earnings before tax (EBT) + interest expense + amortization expense

Since certain industries require significant investment in fixed assets, EBITDA can distort a company's profitability by ignoring depreciation. In such cases, EBITA is a more appropriate measure.

When amortization is equal to zero, EBITA is equal to EBIT.

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## BREAKING DOWN 'EBITA'

As a telecom, AT&T Inc. (T) must invest in, maintain and periodically replace a massive portfolio of fixed assets in order to keep its network running. As of December 31, 2014, its balance sheet showed net property, plant and equipment assets of \$113 billion, compared to total assets of \$293 billion and current assets of just \$32 billion. Seeing that, investors should be hesitant to ignore depreciation on these assets; in other words, an EBITDA calculation for AT&T would hide more than it would show. Calculating EBITA, however, is tricky given the presentation of the income statement (all figures in millions of USD):

 Operating revenues Service 118,437 Equipment 14,010 Total operating revenues 132,447 Operating expenses Cost of services and sales 60,611 Selling, general and administrative 39,697 Abandonment of network assets 2,120 Depreciation and amortization 18,273 Total operating expenses 120,701 Operating income 11,746 Interest expense 3,613 Equity in net income of affiliates 175 Other income (expenses) – net 1,652 Income before income taxes 9,960 Net income 6,518 Net income attributable to ATT 6,224

Depreciation and amortization are lumped together here, so separating them requires us to read the notes to the company's 10-K filing, which is available on the SEC's website. In note 6, the firm puts depreciation at \$17,773 million for 2014 (it also explains the "abandonment of network assets" expense). Depreciation expenses, in other words, are nearly three times the year's net earnings, underscoring how dangerous it is – in the case of AT&T, at least – to discount depreciation as a non-operating expense.

AT&T's EBITA for 2014 is equal to its earnings before tax (EBT) (\$9,960 m) plus interest expense (\$3,613 m) plus amortization (\$18,273 m - \$17,773 m):

EBITA = \$9,960 m + \$3,613 m + (\$18,273 m - \$17,773 m) = \$14,073 m

Now the only question is: what does that tell us? Comparing AT&T's \$14.1 billion EBITA to its EBITDA of \$31.8 billion (=\$14,073 m + depreciation of \$17,773 m) shows how intensive the company's capital expenditures (capex) are – but we knew that. We should consider EBITA an adjustment of EBITDA, one which takes note of Warren Buffett's point that the tooth fairy does not fund capex. So what is the logic behind EBITDA?

## EBITA in Context

EBITDA emerged in the 1980s during a spate of leveraged buyouts. It was intended to give a picture of how well a company could service its debts, but soon took on a life of its own, becoming a way to state more attractive earnings than the actual bottom line. Since it is a non-GAAP​ measure, there is no requirement that companies use consistent criteria when calculating EBITDA from quarter to quarter. Further adjustments can be made to the already-adjusted figure, in effect allowing for subjective interpretations of a company's "true" earnings.

The rationale behind earnings before interest and tax (EBIT), the first layer of adjustment to net earnings, is to show the money available to service debts. This measure is similar to operating income and often conflated with it, but EBIT is a non-GAAP measure. The reason some analysts go on to deduct depreciation and amortization is that these are non-cash items, so a company's EBITDA is a proxy for cash available to pay off debts. There is, however, no real need to devise proxies for a company's cash flow, since every public firm reports detailed quarterly and annual cash flow statements. In any case, EBITDA and cash flow are distinct because EBITDA is based on the accrual method of accounting, in which revenues and expenses are booked before cash actually changes hands.

Comparisons between a company's net earnings, EBT, EBIT, EBITA and EBITDA allow investors to get a sense of a company's tax burden, debt, operating profitability and capex. Each adjustment isolates a different variable, and comparing companies in the same industry using these measures can reveal the impact each of these expenditures makes on firms relative to one another. In this way, the adjustments are useful.

Reported out of context, however, EBITA and EBITDA can obscure or distort the reality. Instead of using AT&T's net income of \$6.2 billion, an investor might focus on its EBITA (over twice as high) or its EBITDA (a full five times as high) and find the stock's valuation simply dazzling. Warren Buffett proposed a useful thought experiment on the subject in his 2002 letter to Berkshire Hathaway Inc. (BRK-A) shareholders:

"Imagine, if you will, that at the beginning of this year a company paid all of its employees for the next ten years of their service (in the way they would lay out cash for a fixed asset to be useful for ten years). In the following nine years, compensation would be a 'non-cash' expense—a reduction of a prepaid compensation asset established this year. Would anyone care to argue that the recording of the expense in years two through ten would be simply a bookkeeping formality?"

EBITA and other adjusted earnings figures provide useful tools for comparison, but they can easily derail disciplined analysis. Companies report net earnings, operating income and cash flow according to set standards; these measures deserve more attention than approximations obtained through adjustments.

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