What is the 'EBITDA to sales ratio'
The EBITDA to sales ratio is a financial metric used to assess a company's profitability by comparing its revenue with earnings. More specifically, since EBITDA is derived from revenue, this metric indicates the percentage of a company's earnings remaining after operating expenses. Sometimes referred to as EBITDA margin, a higher value is appreciated for this ratio as it indicates the company is able to keep its earnings at a good level via efficient processes that have kept certain expenses low.
BREAKING DOWN 'EBITDA to sales ratio'In some sense, EBITDA can also be viewed as a liquidity measurement. Because a comparison is being made between the total revenue earned and the residual net income before certain expenses, EBITDA to sales ratio reports the total amount a company can expect to receive after operating costs have been paid. Although this is not a true sense of the concept of liquidity, the calculation still reveals how easy it is for a business to cover and pay for certain costs.
Calculation of EBITDA
EBITDA is calculated by deducting all expenses from net revenues except interest, taxes, depreciation and amortization. It is not a financial ratio but rather a profitability measurement reported in dollars. The purpose of EBITDA is to report earnings prior to certain expenses that are considered uncontrollable. EBITDA provides deeper insight as to the operational standing of an organization based on the costs management can control.
Calculation of EBITDA to Sales Ratio
A calculation equal to 1 regarding the EBITDA to sales ratio indicates a company has no interest, taxes, depreciation or amortization. Therefore, it is virtually guaranteed the calculation of a company’s EBITDA to sales ratio will be less than 1 because of the additional deduction of expenses. Because of the impossibility of a negative amount for these expenses, the EBITDA to sales ratio should not return a value greater than 1. A value greater than 1 is an indicator of a miscalculation.
Usefulness of EBITDA to Sales Ratio
The EBITDA to sales ratio is most useful when comparing similar-sized companies within the same industry. Because different companies have different cost structures across industries, the EBITDA to sales ratio calculations only hold value during comparison if the underlying variables are known. For example, certain industries may experience more favorable taxation due to tax credits and deductions. These industries incur lower income tax figures and higher EBITDA to sales ratio calculations.
Another aspect in regards to the usefulness of the EBITDA to sales ratio relates to the use of depreciation and amortization methods. Because companies can select different depreciation methods, EBITDA to sales ratio calculations eliminate the depreciation expense from consideration to improve consistency between companies.