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:
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How to Calculate EBITDA Margin
While revenue is the starting line item on a company’s income statement, EBITDA is a non-GAAP metric intended to represent a company’s core profitability on a normalized basis.
So in short, the EBITDA margin answers the following question:
- “For each dollar of revenue generated, what percentage trickles down to become EBITDA?”
Before we delve deeper into the metric, review the primer on EBITDA to ensure the concept is fully understood.
EBITDA Quick Primer
In order to understand the importance of a company’s 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, i.e. 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.
EBITDA Margin Formula
The formula for calculating the EBITDA margin is as follows.
- EBITDA Margin = EBITDA ÷ Revenue
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 simple scenario, our company’s margin is 50%, which we computed from $5 million in EBITDA divided by the $10 million in revenue.
Why the EBITDA Margin Matters
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 Adjusted EBITDA (Source: WSP Financial Statement Modeling)
How to Interpret EBITDA Margin
For comparisons of any profit margin 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 are 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 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 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).
Learn More → EBITDA Margin by Sector (Damodaran)
EBITDA Margin vs. Operating Margin (EBIT)
While the EBITDA margin is arguably the most commonly used profit margin, there are others, such as the following:
- Operating Margin = EBIT ÷ Revenue
The critical difference between the EBITDA and operating margin is the exclusion (i.e. 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 in comparison.
The operating profit (EBIT) is an accrual GAAP measure of profit, whereas the EBITDA metric is a GAAP/cash hybrid profit margin.
EBITDA Margin Calculator – Excel Model Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
EBITDA Margin Calculation Example
Suppose we’re tasked with calculating and comparing the EBITDA margin of three different 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).
Company A, Income Statement:
- Revenue = $100m
- Cost of Goods Sold (COGS) = –$40m
- Operating Expenses (OpEx) = –$20m
- Depreciation and Amortization (D&A) = –$5m
Company B, Income Statement:
- Revenue = $100m
- Cost of Goods Sold (COGS) = –$30m
- Operating Expenses (OpEx) = –$30m
- Depreciation and Amortization (D&A) = –$15m
Company C, Income Statement
- 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 the calculated EBITDA by revenue.
Upon entering our inputs into the appropriate formula, we arrive at a 40.0% margin.
- 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.
The EBITDA margins are identical for all three companies, yet operating margins range from 25.0% to 35.0% while net income margins range from 3.5% to 22.5%.
But still, the fact that the profit metric is less susceptible to discretionary accounting and management decisions causes EBITDA to remain one of the most practical and widely accepted metrics for comparison.