What Is EBITDA Margin?
EBITDA margin is a measure of a company's operating profit as a percentage of its revenue. The acronym stands for earnings before interest, taxes, depreciation, and amortization. Knowing the EBITDA margin allows for a comparison of one company's real performance to others in its industry.
There are a couple of alternatives to EBITDA that are used by investors and analysts working to understand a company's profitability:
- EBITA is earnings before interest, taxes, and amortization
- EBIT is earnings before interest and taxes and is also known as operating margin
In any case, the formula for determining operating profitability is a simple one. EBITDA (or EBITA or EBIT) divided by total revenue equals operating profitability.
So, a firm with revenue totaling $125,000 and EBITDA of $15,000 would have an EBITDA margin of $15,000/$125,000 = 12%.
- EBITDA focuses on the essentials of a business: its operating profitability and cash flow.
- EBITDA margin is earnings divided by revenue.
- That number is the company's operating profitability.
How EBITDA Is Used
No analyst or investor would argue that a company's numbers on interest, taxes, depreciation, and amortization are irrelevant. Nevertheless, EBITDA strips all of those numbers out in order to focus on the essentials: operating profitability and cash flow.
That makes it easy to compare the relative profitability of two or more companies of different sizes in the same industry. The numbers otherwise could be skewed by short-term issues or disguised by accounting maneuvers.
Calculating a company's EBITDA margin is helpful when gauging the effectiveness of a company's cost-cutting efforts. The higher a company's EBITDA margin is, the lower its operating expenses are in relation to total revenue. (For related reading, see "How Do I Calculate an EBITDA Margin Using Excel?")
Therefore, a good EBITDA margin is a relatively high number in comparison with its peers. Similarly, a good EBIT or EBITA margin is a relatively high number.
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 a 3% dip in annual revenue.
GAAP and Non-GAAP
EBITDA is known as a non-GAAP financial figure, meaning it does not follow generally accepted accounting principles (GAAP). The GAAP standards are critical in ensuring the overall accuracy of financial reporting, but they can be superfluous to financial analysts and investors. That is, interest, taxes, depreciation, and amortization are not part of a company's operating costs and are therefore not associated with the day-to-day operation of a business or its relative success.
Advantages and Disadvantages of EBITDA Margin
The EBITDA margin tells an investor or analyst how much operating cash is generated for each dollar of revenue earned. That number can then be used as a comparative benchmark.
A good EBITDA margin is a higher number in comparison with its peers. A good EBIT or EBITA margin also is the relatively high number.
For example, a small company might earn $125,000 in annual revenue and have an EBITDA margin of 12%. A larger company earned $1,250,000 in annual revenue but had an EBITDA margin of 5%. Clearly, the smaller company operates more efficiently and maximizes its profitability while the larger company probably focused on volume growth to increase its bottom line.
Pitfalls of EBITDA
The exclusion of debt has its drawbacks when measuring the performance of a company.
Some companies highlight their EBITDA margins as a way to draw attention away from their debt and enhance the perception of their financial performance.
Companies with high debt levels should not be measured using the EBITDA margin. Large interest payments should be included in the financial analysis of such companies.
In addition, EBITDA margin is usually higher than profit margin. Companies with low profitability will emphasize EBITDA margin as their measurement for success.
Finally, companies using the EBITDA figure are allowed more discretion in calculating it because EBITDA isn't regulated by GAAP. A firm can skew the figure in its favor.