What is EBITDA Margin
EBITDA margin is an assessment of a firm'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
The EBITDA margin figure is helpful in comparing the profitability of different companies while factoring out the effects of decisions related to financing and accounting. Its simple formula is as follows:
(Earnings Before Interest, Tax, Depreciation and Amortization) / Total Revenue
Therefore, a firm with revenue totaling $125,000 and EBITDA of $15,000 would have an EBITDA margin of $15,000/$125,000 = 12%.
Calculating an EBITDA margin is a helpful metric when gauging the effectiveness of a firm's cost-cutting efforts. The higher a company's EBITDA margin is, the lower that company's operating expenses are in relation to total revenue. For example, after lowering its yearly expenses by nearly 17% in 2017, Twitter saw its EBITDA margin rise to 35%, compared to about 30% the prior year. The firm's EBITDA margin grew despite slight resistance from a 3% dip in annual revenue.
The EBITDA Margin Versus Other Profit Margins
EBITDA is a non-GAAP financial figure that measures a company's profitability before deductions that are considered somewhat superfluous to the business decision-making process. These deductions are interest, taxes, depreciation and amortization, all of which are not part of a company's operating costs and are therefore not associated with the maintenance and administration of a business on a day-to-day basis.
EBITDA margin differs from the operating margin, which excludes depreciation and amortization from the profitability measure. Other variations of a firm's profit margin include gross profit margin, net profit margin and after-tax profit margin. For more on the differences between EBITDA margin and other profitability margins, see: What is the difference between EBITDA margin and profit margin?
Benefits of the EBITDA Margin
Calculating the EBITDA margin allows people to compare companies of different sizes in different industries because it breaks down operating profit as a percentage of revenue. This means that an 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.
Considering 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, companies using the EBITDA figure are allowed more discretion in its calculation because EBITDA as an accounting number isn't regulated by GAAP, meaning firms can ultimately skew the figure in their favor.