What is 'EBITDA Margin'
EBITDA margin is a measurement of a company's operating profitability as a percentage of its total revenue. It is equal to earnings before interest, tax, depreciation and amortization (EBITDA) divided by total revenue. Because EBITDA excludes interest, depreciation, amortization and taxes, EBITDA margin can provide an investor, business owner or financial professional with a clear view of a company's operating profitability and cash flow.
BREAKING DOWN 'EBITDA Margin'
For example, a firm with revenue totaling $125,000 and EBITDA of $15,000 would have an EBITDA margin of $15,000/$125,000 = 12%. 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.
EBITDA is a financial number that measures a company's profitability before deductions that are considered somewhat superfluous to the business decision-making process. These deductions are interest, taxes, deprecation and amortization, which are not part of a company's operating costs and although important, should be dealt with separately.
Benefits of the EBITDA Margin
Calculating the EBITDA margin allows people to compare and contrast companies of different sizes in different industries because it breaks down operating profit as a percentage of revenue. This means that a investor, owner or analyst can understand how much operating cash is generated for each dollar of revenue earned and use the margin as a comparative benchmark.
Using the example above, if a small company earned $125,000 in annual revenue and had an EBITDA margin of 12%, its performance can be compared with a larger company that earned higher total revenue. If the larger company earned $1,250,000 in annual revenue but had an EBITDA margin of 5%, it becomes clear that the smaller company operates more efficiently as a way to maximize profitability while the larger company has likely decided to focus on volume growth in order to increase its bottom line. This allows people to make informed business and investment decisions.
Drawbacks of the EBITDA Margin
The exclusion of debt has its drawbacks when measuring the performance of a company. For this reason, some companies deceptively use the EBITDA margin as a way to increase the perception of its financial performance. For example, companies with high debt shouldn't be measured using the EBITDA margin because the larger mix of debt-to-equity increases interest payments, which should be included in the analysis of a company with high debt.
Further, EBITDA margin is usually higher than profit margin, and companies with low profitability will rely on EBITDA margin as a measurement for success. Finally, EBITDA as a accounting number isn't regulated by GAAP, and companies can potentially skew EBITDA numbers.