What does EBITA mean and when is it useful?

Revolut Contributor

 · July 06, 2020  · 07/06/2020

EBITA (i.e. Earnings Before Interest, Tax, and Amortisation) is a profit metric which reveals the financial performance of a business without taking specific categories of expense into account. The costs that EBITA excludes are the interest owed on loans, taxes due, and the amortisation of intangible assets (e.g. patents).

The EBITA is a hybrid of two rival profit metrics. These are the EBIT – which excludes interest and tax but not amortisation – and EBITDA, which is identical to EBITA other than it excludes depreciation too. In short, the EBITA separates the depreciation and amortisation costs, so a business sees the effect of each one in isolation from the other.

How is EBITA calculated?

There are two ways to calculate the EBITA (pronounced EE-BEE-TAH). You either start with revenue for a given period and make appropriate deductions, or you take the figure for net profit shown on the income statement and add back interest, tax, and amortisation.

Net profit = Revenue – Total costs

EBITA = Net profit + Interest + Tax + Amortisation

For clarity, the EBITDA formula goes one step further by adding back the cost allowed for depreciation. This sum reflects the decline in the monetary value of long-term physical assets that the business owns, such as machinery, over their useful economic lifespan.

EBITDA = EBITA + Depreciation

When is the EBITA metric useful?

The EBITA is a handy way to examine the profits of a business that needs hefty investments in fixed assets to operate, such as a manufacturer, because it excludes this type of cost. Given that the EBITA separates the effects of depreciation and amortisation, it is an effective tool whenever there is a significant disparity between these two cost categories.

Amortisation is the allowance made in the accounts to reflect the falling or impaired value of intangible business assets, such as patents or goodwill. There are specific rules for these assets and the lack of open markets – certainly, compared to physical items – makes it tricky to value them reliably. The International Financial Reporting Standards (IFRS) provides detail here.

Let's take an example. Avocado Ltd is a fictional firm that makes fruit-shaped furniture in London. Last year, the business made £80k in net profits compared to £100k for the following period. The investors ask managers to explain this drop.

During year one, Avocado struggled to fulfil orders, due to ageing machinery. In year two, the business took a loan to buy a lathe and paid a chunky sum on a licence for fabric design.

These purchases led to higher revenue and more gross profit. However, to reflect the long-term nature of its investments, Avocado adds annual costs onto its income statement from year two onwards of £50k in depreciation, £25k in amortisation, and £25k interest.

 

Year One

Year Two

Gross profits

£150k

£225k

Depreciation

None

£50k

Amortisation

None

£25k

Other operating costs

£25k

£25k

Operating profit (i.e. EBIT)

£125k

£125k

Interest 

None

£25k

Tax 

£25k

£20k

Net profit

£100k

£80k

EBITA

£125k

£150k

EBITDA

£125k

£200k

The new costs mean that net profits do fall, once the business takes the loan interest and the tax owed into account. Even so, Avocado can prove that its business remains strong by excluding (i.e. adding back) specific cost-categories to provide more nuanced profit metrics.

Adding back the interest and tax shows that the operating profit (often called EBIT) remains constant in year two. The add-back of amortisation costs, too, then reveals that the EBITA has increased over this second period. If it also adds back the depreciation cost, the business shows its underlying EBITDA metric has almost doubled from one year to the next.

What is a good EBITA margin?

The EBITA has a specific monetary value. To convert this into its margin ratio, you divide that figure by the total revenue over the same time and then multiply by one hundred to create a percentage. The result shows how much EBITA a business generates per pound of revenue.

EBITA Margin = (EBITA/Revenue) x100

As with most financial metrics, it's more insightful to compare EBITA to the same metric from earlier periods, a forecast, or an industry benchmark than to define one arbitrary value as a 'good' result. The nature of this obscure profit metric means that it's helpful to use EBITA in combination with rivals, such as EBIT and EBITDA, to gain a broader view of the business.

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