What it means
Most profit measures stop at either end of the tax and interest lines. EBIT, or earnings before interest and taxes, ignores both, while net income is struck after both.
EBIAT sits in between: it deducts tax but leaves interest out, so it isolates the profit from running the business after the tax authority has taken its share. The figure is useful because debt can distort comparisons.
Two companies with identical operations will report different net income if one is funded with lots of borrowing and the other is not. By leaving out interest, EBIAT puts them on an equal footing, while including tax reflects the real cash cost of operating.
Analysts often use EBIAT as a building block for valuation. It is the same as net operating profit after tax, or NOPAT, which is a key input to discounted cash flow models and to measures such as return on invested capital.
The tax is calculated as if the company had no interest expense, which is why it differs from the tax actually paid. Using the right tax rate is the main judgement.
Some analysts use the statutory rate, which is the headline rate set by law, while others use the effective rate that the company actually pays after reliefs and deductions. The choice should be stated clearly so that comparisons are fair.
EBIAT does not include the cost of replacing worn-out equipment or the cash needed for growth. It also ignores the tax savings that come from borrowing, because interest is a tax-deductible cost in many systems.
For a complete picture, analysts look at it together with cash flow measures and with the capital the business uses. In practice, EBIAT appears in many corporate finance exercises.
It is the starting point for estimating free cash flow, because you add back depreciation, subtract capital spending and adjust for working capital. It is also the numerator in return on invested capital, which tells a board whether the business earns more than it costs to fund.
In practice
Real-world examples.
Example
A private equity analyst compares two manufacturers, one heavily indebted and one with little debt. She calculates EBIAT for both so that differences in borrowing do not distort the comparison. She then compares each result with the capital employed.
Example
A finance team builds a cash flow forecast for a new factory with EBIT of $2,000,000 a year and a 30% tax rate. The EBIAT of $1,400,000 becomes the starting point for estimating free cash flow.
Example
A company tests whether a new division earns more than the cost of the money invested in it. The division's EBIAT of $90,000 on $1,000,000 of capital gives a return of 9%, which falls short of the 11% the company needs. Management decides to improve the division's margins or close it.
Formula
Calculation
EBIAT = EBIT x (1 - Tax rate)
Worked example: a company has EBIT of $500,000 and a tax rate of 25%.
Tax on operating profit = $500,000 x 25% = $125,000
EBIAT = $500,000 - $125,000 = $375,000
Check using the formula: $500,000 x (1 - 0.25) = $500,000 x 0.75 = $375,000
If the company has invested capital of $3,000,000, its return on invested capital is $375,000 / $3,000,000 = 12.5%.Case study
Seen in the real world.
Harbor Lights Dairy is a fictional business weighing up a $4,000,000 new processing plant. The board's finance lead, Mr Nakamura, needed to estimate whether the plant would earn a sensible return for the capital invested.
He forecast EBIT of $640,000 a year from the plant and used a tax rate of 25%, giving EBIAT of $640,000 x 0.75 = $480,000. Dividing by the $4,000,000 investment gave a return of 12%. The company's cost of capital was 9%, so the plant looked as though it would create value.
This illustrative example shows that EBIAT puts the project on the same basis as the funding costs it must beat. The board approved the plant, while asking for a sensitivity test to see what would happen if EBIT came in 20% lower. At that level EBIAT would be $384,000, a return of 9.6%, still just above the cost of capital.
Watch out
Common mistakes.
- Using the tax actually paid, which already includes the tax saving from interest, instead of tax calculated on operating profit.
- Confusing EBIAT with net income, when net income deducts interest as well.
- Forgetting that EBIAT is not cash flow, since it does not deduct capital spending or changes in working capital.
Questions
People also ask.
Is EBIAT the same as NOPAT?
In most uses yes, as both measure operating profit after tax and before financing costs. The name NOPAT is more widely used in valuation textbooks.
Why leave out interest?
Interest depends on how a company is funded, so excluding it lets you judge the operations alone.
Which tax rate should I use?
Use either the statutory or the effective rate, but state your choice and apply it consistently across companies.
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