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What’s it: EBIAT margin is a profitability ratio to measure how efficiently a company generates profit from all its activities before paying interest expense while taking taxes into account. We calculate it by dividing EBIAT by revenue. EBIAT is an alternative to profit metrics other than EBIT, EBITDA, net income, operating profit, and NOPAT.
As with other profit margins, higher EBIAT margins are better. If the EBIT margin increases, the company generates revenue at lower costs, including those from its non-operating activities. On the contrary, it is worse.
Then, the EBIAT margin does not show what percentage of cash is booked from each revenue. This is because when calculating EBIAT, we still include non-cash items such as depreciation and amortization.
How to calculate the EBIAT margin?
To calculate the EBIAT margin, we must first obtain the earnings before interest after tax (EBIAT) figures. It equals EBIT times one minus the tax rate.
- EBIAT = EBIT x (1 – Tax rate)
EBIT, which stands for earnings before interest and tax, represents the profit recorded by the company before being paid as taxes and interest. So, to get EBIAT, we deduct the tax burden for each recorded EBIT.
Some analysts may use a different approach in calculating EBIT. Under the first approach, they start from the revenue. Then, they calculate EBIT by subtracting revenue by the cost of goods sold (COGS); selling, general and administrative expenses; and totaling the result with non-operating gain (loss) after adjusting for interest expense.
Meanwhile, under the second approach, analysts start from the net profit. Then, they add back the interest and deduct the result with taxes.
After getting EBIAT, we divide it by revenue to get the margin figure. Here is the EBIAT margin formula:
- EBIAT margin = EBIAT / Revenue
For example, a company reports revenues of $2 million and EBIT of $500,000. If the corporate tax rate is 15%, then EBIAT equals $425,000 = $500,000*(1 – 15%). Meanwhile, the EBIAT margin is equal to 21.25% = $425,000/$2 million.
Non-operating items
We may have different views on whether to include non-operating gains (losses) or not. And the decision is at our discretion.
In one case, we might exclude non-operating gains (losses) because their items are non-recurring. Some accounts can increase sharply in the previous year but not appear in the following year. Thus, we exclude them because they fluctuate and can affect conclusions.
Meanwhile, we may include it in other cases because it has material implications for recorded EBIAT. For example, we might consider taking investment gains into account because they are significant and relatively stable over time. Moreover, the company has a large cash balance to continue to invest in the future.
How to interpret the EBIAT margin?
As previously explained, the EBIAT margin measures how efficiently the company generates profit (EBIAT). When companies are more efficient, they generate revenue at lower costs, leading to higher EBIAT increases than revenue increases.
Thus, a higher EBIAT margin indicates better efficiency and, therefore, is preferred. Companies can book revenue more profitably than ever before. Thus, the recorded revenue is translated into a higher profit.
Conversely, a lower margin indicates the opposite condition. Less revenue is left as most of it is paid out as expenses. As a result, less profit is available to pay interest to creditors. If it is lower than interest expense, companies may be insolvent, where they are unable to meet maturing obligations.
Why use EBIAT?
EBIAT measures how much profit is available to pay its creditors after accounting for tax payments. Therefore, we add back the interest to determine how much profit is made before paying creditors.
Unlike EBIT or EBITDA, we take the tax burden into account. Meanwhile, EBIT and EBITDA exclude it. Why include taxes in the calculation? That’s because taxes are beyond management’s control. Companies cannot influence the tax rate charged to them. But, just like interest expense, they must pay it.
On the other hand, interest expense may differ slightly from tax. Companies can have control over this item, namely by managing leverage wisely. Say the company wants to lower interest expenses. They can take on less debt and more equity (e.g., through rights issues) when they need funds for expansion.
Furthermore, we can say EBIAT is a proxy for the cash generated by the firm during the accounting period if non-cash items such as depreciation and amortization expenses are relatively small. EBIAT can be a pretty good indicator than EBITDA. EBITDA does exclude depreciation and amortization, but it doesn’t take into account how much cash is required to pay taxes. Thus, if depreciation and amortization are small, analysts may focus more on EBIAT than EBITDA.
