EBITDA margin is a profitability ratio that measures how much in earnings a company is generating before interest, taxes, depreciation, and amortization, as a percentage of revenue. EBITDA Margin = EBITDA / Revenue.
The margin does not include the impact of the company’s capital structure, non-cash expenses, and income taxes. This ratio may be used in conjunction with other leverage and profitability ratios to evaluate a company. To learn more, launch CFI’s online finance courses now!
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What is the Formula for EBITDA Margin?
The first step to calculate EBITDA is to get the earnings before interest and tax (EBIT) from the income statement. The next step is to add back the depreciation and amortization expenses (to learn more, compare EBIT vs EBITDA).
EBITDA = Operating Income (EBIT) + Depreciation + Amortization
To compute the EBITDA ratio the following formula is used:
LMN company declared a net profit, before taxes and interest, of $3M for year-end 2015. Net sales reported in the income statement shows an amount of $5M. Depreciation and amortization total $100,000.
Given the figures, the EBITDA margin is calculated as 62%, implying that the remaining 38% of sales revenue accounts for the operating expenses (excluding depreciation and amortization).
The higher the EBITDA margin, the smaller a company’s operating expenses in relation to total revenue, increasing its bottom line and leading to a more profitable operation.
What are the Benefits of Using EBITDA Margin in Determining Business Profitability?
EBITDA margin is considered to be the cash operating profit margin of a business before capital expenditures, taxes, and capital structure are taken into account. It eliminates the effects of non-cash expenses such as depreciation and amortization. Investors and owners can get a sense of how much cash is generated for every dollar of revenue earned and use the margin as a benchmark in comparing various companies.
EBITDA is widely used in mergers and acquisitions of small businesses, the middle market, and large public companies. It is not unusual for adjustments to be made to EBITDA to normalize the measurement, allowing buyers to compare the performance of one business to another.
A low EBITDA margin indicates that a business has profitability problems as well as issues with cash flow. On the other hand, a relatively high EBITDA margin means that the business earnings are stable.
Since EBITDA excludes interest on debt, non-cash expenses, capital expenditures, and taxes, it does not necessarily provide a clear estimate of what cash flow generation for the business is. As an alternative, investors should look at cash flow from operations on the cash flow statement, or calculate Free Cash Flow (learn more in CFI’s Ultimate Cash Flow Guide).
For companies with high debt capitalization, the EBITDA margin should not be applied, because the larger mix of debt over equity increases interest payments, and this should be included in the ratio analysis for this kind of business.
A positive EBITDA does not necessarily mean a business is generating cash. This is because EBITDA ignores changes in working capital, which is usually needed in growing a business. Additionally, it does not take into account capital expenditures that are needed to replace assets on the balance sheet.
Lastly, EBITDA margin is not recognized in generally accepted accounting principles – GAAP.
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