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. Operating expenses include the cost of goods sold (COGS) and selling, general, and administrative (SG&A) expenses.

The ratio focuses on direct operating costs while excluding the effects of the company's capital structure by omitting interest, omitting non-cash depreciation and amortization expenses, and omitting income taxes.

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.

The Formula for the EBITDA-To-Sales Ratio

EBITDAmargin=EBITDANet salesEBITDA\;\text{margin} = \frac{EBITDA}{\text{Net sales}}EBITDAmargin=Net salesEBITDA

How to Calculate the EBITDA-To-Sales Ratio

EBITDA is an abbreviation for "earnings before interest, taxes, depreciation, and amortization." Thus, it is calculated by deducting all expenses from earnings, also known as net revenues, except for interest, taxes, depreciation, and amortization.

What Does the EBITDA-To-Sales Ratio Tell You?

The purpose of EBITDA is to report earnings prior to certain expenses that are considered uncontrollable. EBITDA provides deeper insight into the operational standing of an organization based on the costs management can control.

The EBITDA-to-sales ratio is equal to EBITDA-to-sales. A calculation equal to 1 would indicate that a company has no interest, taxes, depreciation or amortization. It is thus virtually guaranteed that 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.

In some sense, EBITDA can also be viewed as a liquidity measurement. Because comparison is being made between the total revenue earned and the residual net income before certain expenses, the EBITDA-to-sales ratio shows 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.

Key Takeaways

  • The EBITDA-to-sales ratio (EBITDA margin) can show how much cash a company generates for each dollar of sales revenue.
  • It's common for EBITDA to be adjusted to "normalize" it across a group of companies, for use in mergers and acquisitions of various-sized companies.
  • A low EBITDA-to-sales ratio reveals that a company may have problems with profitability as well as its cash flow, while a high result may indicate a solid business with stable earnings.

Limitations of the EBITDA-To-Sales Ratio

The EBITDA-to-sales ratio for a given company is most useful when comparing to similar-sized companies within the same industry. Because different companies have different cost structures across industries, the EBITDA-to-sales ratio calculations won't tell much during comparison if used to compare against industries with different cost structures.

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 related to the usefulness of the EBITDA-to-sales ratio concerns 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.