What Is EBITA
EBITA, which stands for earnings before interest, taxes, and amortization is a method of determining profitability. This figure represents what an entity earned before the deduction of taxes, interest on loans and a reduction for amortization, a paying off debts over time. Many will use this number to represent how efficient a company is in its operations in comparison to another similar business. It is also a cash flow indicator.
EBITA is a variation of the more commonly used EBITDA, which adds depreciation into the calculation. Depreciation is the accounting for the cost of an asset over its lifespan. Some companies such as those in the utilities, manufacturing and telecommunications industries require significant expenditures in equipment and infrastructure which they hold on their books.
Both metrics are useful in gauging a company's operating profitability. Profitability is earnings generated throughout the ordinary course of doing business. It does not take into its accounting capital expenditures and financing costs.
Analysts consider both EBITA and EBITDA to be reliable indicators of a company’s cash flow. However, because specific industries require significant investment in fixed assets, EBITA can potentially distort a company's profitability by ignoring the depreciation of those assets. Therefore, EBITA is deemed to be a more appropriate measure of operating profitability. In other words, the EBITA metric may replace the EBITDA metric, for companies that have substantial capital expenditures (CapEX) which may skew the ratio.
Calculation of EBITA
To calculate a company's EBITA an analyst should first determine the company’s earnings before tax (EBT). This figure comes from a company's income statements and other investor relations materials. Add to this figure any interest and amortization costs. Amortization refers to the process of gradually writing off the initial cost of an asset. (EBITA = earnings before tax (EBT) + interest expense + amortization expense)
Real World Example
In 2016, XYZ company took in US$600,000 and earned a net profit of $390,000 for that year. The business subsequently took out a loan to renovate their sales floor. The following year, sales rose to one million dollars, but net profit decreased to $382,000, down from the previous year. Employing the EBITA calculation the firm's earnings before interest, taxes and amortization increased between the recorded years, but the net profit decreased due to the cost of renovations.
This example demonstrates the grave importance of studying multiple metrics when evaluating the performance of a business. At first glance, it would seem the business performed worse in the second reported year because it did not take into account the cost of renovations completed.