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Guide to Understanding the EBITDA Margin

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In This Article
  • The EBITDA margin is the ratio between a company’s EBITDA and net revenue, expressed as a percentage.
  • The EBITDA margin is a non-GAAP measure of operating performance intended to measure a company’s core profitability on a normalized basis.
  • The formula to calculate EBITDA margin is EBITDA divided by net revenue in the corresponding period.
  • A “good” EBITDA margin is relative to the specific industry in question, however, an EBITDA margin in excess of 10% is perceived positively by most.

How to Calculate EBITDA Margin?

As we’ve described earlier, the EBITDA margin is the ratio between EBITDA and revenue.

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?”

To calculate the EBITDA margin, the steps are as follows:

  1. Gather the revenue, cost of goods sold (COGS), and operating expenses (OpEx) amounts from the income statement.
  2. Obtain the depreciation and amortization (D&A) amount from the cash flow statement (CFS), including other non-cash add-backs.
  3. Calculate operating income, or “EBIT”, by subtracting COGS and OpEx from revenue, and then adding back D&A.
  4. Divide the EBITDA amounts by the corresponding revenue figure to arrive at the EBITDA margin for each company.

But before we delve deeper into the metric, review the primer on EBITDA to ensure the profit metric is fully understood.

Quick EBITDA Concept Review

In order to understand the importance of a company’s EBITDA margin, it is critical first to understand the importance of EBITDA – an abbreviation for the term, “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.

Learn More → EBITDA Primer

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.

What is a Good EBITDA Margin?

The 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:

  1. Compares against its own historical results (i.e. profitability trends from the previous periods)
  2. Compare vs. competitors in the same (or relatively similar) industries

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 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).

Learn MoreEBITDA Margin by Sector (Damodaran)

What is the Difference Between EBITDA Margin vs. Operating Margin?

While the EBITDA margin is arguably the most commonly used profit margin, there are others, such as the following:

The closest cousin of the EBITDA margin profitability metric is the operating margin – calculated as EBIT ÷ Revenue – where EBIT is defined as the revenue less ALL operating expenses, including depreciation and amortization (D&A).

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

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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1. Income Statement Operating Assumptions

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 begin, we’ll first list out the assumptions for revenue, cost of goods sold (COGS), and operating expenses (OpEx), as well as depreciation and amortization (D&A).

Company A, Income Statement

  • Revenue = $100m
  • Cost of Goods Sold (COGS) = –$40m
  • Operating Expenses (SG&A) = –$20m
  • Depreciation and Amortization (D&A) = –$5m

Company B, Income Statement

  • Revenue = $100m
  • Cost of Goods Sold (COGS) = –$30m
  • Operating Expenses (SG&A) = –$30m
  • Depreciation and Amortization (D&A) = –$15m

Company C, Income Statement

  • Revenue = $100m
  • Cost of Goods Sold (COGS) = –$50m
  • Operating Expenses (SG&A) = –$10m
  • Depreciation and Amortization (D&A) = –$10m

2. EBITDA Margin Calculation Example

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%

3. EBITDA Margin Ratio Analysis Example

The operating margin and net income margin of the companies are impacted by their different D&A values, capitalization (i.e. the interest expense burden), and tax rates.

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 (40.0%), 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.

EBITDA Margin Calculator

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