What is the EBITDA Margin?
EBITDA Margin is an important measure of operating efficiency and is defined as EBITDA divided by revenue for a given period and expressed as a percentage, as follows:
- What is the formula used to calculate the EBITDA margin?
- What are some of the shortcomings of the EBITDA margin metric?
- Why is EBITDA margin among one of the most widely used metrics for comparisons?
- Why is the EBITDA margin important?
Table of Contents
EBITDA Margin Formula
As we’ve described earlier, the formula for calculating the EBITDA margin is defined as:
EBITDA Margin Formula
- EBITDA Margin = EBITDA ÷ Revenue
The EBITDA margin answers the question of, “For each dollar of revenue generated, what percentage trickles down to become EBITDA?”
For instance, suppose a company has generated the following results in a given period:
- Revenue: $10 million
- Cost of Goods Sold (Direct Costs): $4 million
- Operating Expenses: $2 million, which include $1 million of depreciation and amortization expenses
In this scenario, the EBITDA margin would be 50% ($5 million in EBITDA divided by the $10 million in revenue).
Confused about how we got $5 million in EBITDA? Read the primer below before proceeding…
EBITDA Quick Primer
In order to understand the importance of EBITDA margin, it is critical first to understand the importance of EBITDA (Earnings Before Interest, Taxes Depreciation and Amortization), which is perhaps the most ubiquitous measure of profitability in corporate finance.
EBITDA reflects the operating profits of a company – revenue less all operating expenses except for depreciation and amortization expense (D&A).
Because EBITDA excludes D&A, it is a measure of operating profits that is undistorted by an often large non-cash accounting charge in each period.
When compared to the amount of revenue generated, the EBITDA margin can be used to determine the operational efficiency of a company and its capacity to produce sustainable profits.
Read more on EBITDA
Importance of EBITDA Margin
EBITDA margin provides a picture of how efficiently a company’s revenue is converted into EBITDA. In practice, a company’s EBITDA margin is usually used to:
- Compares against its own historical results (i.e. profitability trends from the previous periods)
- Compare vs. competitors in the same (or relatively similar) industries
Apple EBITDA Example
Apple EBITDA (Source: WSP Financial Statement Modeling)
Interpreting the EBITDA Margin
For comparisons of the EBITDA margins to be more useful, the companies chosen as part of a peer group should operate in the same industry, or in adjacent ones with similar performance drivers, in order to take into account industry-specific factors.
Generally speaking, higher EBITDA margins tend to be perceived more favorably, as the implication is that the company is producing a higher amount of profits from its core operations.
- Higher EBITDA Margins: Companies with higher EBITDA margins relative to the industry average and vs. historical results are more likely to be more efficient, which increases the likelihood of gaining a sustainable competitive advantage and protecting profits over the long term.
- Lower EBITDA Margins: Companies with lower EBITDA margins compared to peers and declining margins could point to a potential red flag, as it implies the presence of underlying weaknesses in the business model (e.g. targeting the wrong market, ineffective sales & marketing).
EBITDA Margin Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
EBITDA Margin Example Calculation
In our EBITDA margin modeling exercise, we’ll be calculating and comparing the EBITDA margin of three companies.
All three companies are close industry peers and share relatively similar financials in terms of their core operations.
To calculate the EBITDA margin, the steps are as follows:
- Gather the revenue, cost of goods sold (COGS), and operating expenses (OpEx) amounts from the income statement.
- Take the depreciation & amortization (D&A) amount from the cash flow statement, as well as any other non-cash add-backs.
- Calculate the operating income (EBIT) by subtracting COGS and OpEx from revenue, and then adding back D&A.
- Divide the EBITDA amounts by the corresponding revenue figure to arrive at the EBITDA margin for each company.
To begin, we’ll first list out the assumptions for revenue, cost of goods sold (COGS), and operating expenses (OpEx), as well as depreciation & amortization (D&A).
Income Statement – Company A
- Revenue: $100m
- Cost of Goods Sold (COGS): –$40m
- Operating Expenses (OpEx): –$20m
- Depreciation and Amortization (D&A): –$5m
Income Statement – Company B
- Revenue: $100m
- Cost of Goods Sold (COGS): –$30m
- Operating Expenses (OpEx): –$30m
- Depreciation and Amortization (D&A): –$15m
Income Statement – Company C
- Revenue: $100m
- Cost of Goods Sold (COGS): –$50m
- Operating Expenses (OpEx): –$10m
- Depreciation and Amortization (D&A): –$10m
Using the provided assumptions, we can calculate the EBIT for each company by subtracting the COGS, OpEx, and D&A.
Typically, the D&A expense is embedded in either COGS or OpEx, but we have explicitly broken out the amount in this exercise for illustrative purposes.
In the following step, we’ll reconcile the amount by adding back the D&A, which results in EBITDA.
- Company A – EBITDA: $35m EBIT + $5m D&A = $40m
- Company B – EBITDA: $25m EBIT + $15m D&A = $40m
- Company C – EBITDA: $30m EBIT + $10m D&A = $40m
In the final part, the EBITDA margins for each company can be calculated by dividing calculated EBITDA by revenue.
Applying the formula is as follows, we calculate:
- EBITDA Margin = $40m ÷ $100m = 40.0%
In general, the lower on a page a profitability metric is found on the income statement, the greater the effects of the differences in discretionary management decisions related to financing as well as tax differences.
Despite the EBITDA margins being identical for all three companies, operating margins range from 25.0% to 35.0% while net income margins range from 3.5% to 22.5%.
Thanks to being largely unaffected by discretionary accounting and management decisions, EBITDA remains one of the most practical and widely accepted metrics for comparisons.
EBITDA Margin vs Operating Margin
The EBITDA margin is a specific measure of kind of “profit margin.” While it is probably the most commonly used profit margin, there are others, such as gross profit margin, operating margin, and net profit margin.
EBITDA margin’s closest cousin is operating margin, defined as EBIT/Revenue, where EBIT is defined as the revenue less ALL operating expenses (including D&A).
The critical difference between the operating margin and EBITDA margin is the exclusion (in the case of EBITDA) of depreciation and amortization.
Practically speaking, that means that for a company that has D&A expenses, the operating margin will be lower than the EBITDA margin. Operating margin is much closer to an accrual GAAP measure of profit, whereas EBITDA margin is a GAAP/cash hybrid profit margin.