An EBITDA margin is a measure of a company’s operating profit, shown as a percentage of its revenue. EBITDA stands for the Earnings Before Interest, Taxes, Depreciation and Amortization that a company makes.
It is a popular and widely used metric that allows for a direct comparison between companies in terms of what they each earn, as it strips out expenses that may well obscure how a company is truly performing.
There are a few EBITDA margin interpretations used by investors and analysts to understand a company’s profitability:
EBITA is Earnings Before Interest, Taxes and Amortization
EBIT is Earnings Before Interest and Taxes (also known as operating margin)
Typically, an EBITDA margin is used as an alternative to standard measurements of profitability such as net income. Its proponents believe EBITDA margins offer a clearer reflection of financial operations.
Calculating the EBITDA margin
The EBITDA margin formula is reached by dividing EBITDA by total revenue to reveal the company’s profitability.
EBITDA is calculated by taking sales revenue and deducting operating expenses, such as the cost of goods sold and selling, general and administrative expenses, but excluding depreciation and amortization.
EBITDA = Operating Income (EBIT) + Depreciation + Amortization
Then to find the EBITDA margin itself you use the following formula:
EBITDA margin = EBITDA / Sales revenue
The margin doesn’t include the impact of a company’s capital structure, non-cash expenses or income taxes.
EBITDA margin calculation example: A company with revenue totalling £500,000 and EBITDA of £50,000 would have an EBITDA margin of £50,000/£500,000 = 10%
The higher the EBITDA margin, the smaller a company’s operating expenses are in relation to their total revenue, leading to a more profitable operation.
EBITDA margin advantages
An EBITDA margin is considered to be the cash operating profit margin of a business, not taking into account expenditures, taxes and structure. It eliminates the effects of non-cash expenses, allowing investors and analysts to gauge a sense of how much money is generated for every pound of revenue earned. They can then use the margin as a benchmark for comparing against other similar businesses in the industry.
EBITDA margins are often used in mergers and acquisitions. A low EBITDA margin indicates that a business has profitability problems as well as issues with cash flow. A high EBITDA margin suggests that the company's earnings are stable.
EBITDA margin disadvantages
Not including debt in calculating the performance of a company has its negatives. Sometimes a company will highlight its EBITDA margin as a tactic to draw attention away from its debt and enhance the perception of its financial performance.
Companies with high debt levels should not be measured using the EBITDA margin. Instead large interest payments should be included in the ratio analysis.
It is worth noting that a positive EBITDA doesn’t always mean that a business is generating profit. This is because EBITDA ignores changes in working capital, usually needed in growing a business. And it doesn’t take into account capital expenditures, which are needed to replace assets on the balance sheet.
Also, because an EBITDA margin is not regulated by generally accepted accounting principles (GAAP), this means companies using it are allowed more discretion in their calculations.
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