What Is the EBITDA-To-Sales Ratio?
The EBITDA-to-sales ratio, also known as EBITDA margin, is a financial metric used to assess a company's profitability by comparing its gross revenue with its earnings. More specifically, since EBITDA itself is derived in part from revenue, this metric indicates the percentage of a company's earnings remaining after operating expenses. A higher value indicates the company is able to produce earnings more efficiently by keeping costs low.
- The EBITDA-to-sales ratio (EBITDA margin) shows how much cash a company generates for each dollar of sales revenue, before accounting for interest, taxes, and amortization & depreciation.
- A low EBITDA-to-sales ratio suggests 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.
- Because the ratio excludes the impact of debt interest, highly leveraged companies should cot be evaluated using this metric.
The Formula for the EBITDA-To-Sales Ratio
How to Calculate the EBITDA-To-Sales Ratio
EBITDA is an abbreviation for "earnings before interest, taxes, depreciation, and amortization." Thus, it is calculated adding back these line items to net income, and so does include operating expenses such as the cost of goods sold (COGS) and selling, general, and administrative (SG&A) expenses.
The EBITDA/sales ratio is therefore able to focus on the impact of direct operating costs while excluding the effects of the company's capital structure, tax exposure, and accounting quirks.
What Does the EBITDA-To-Sales Ratio Tell You?
The purpose of EBITDA is to report earnings while exlcluding certain expenses that are considered uncontrollable. EBITDA provides deeper insight into the operational efficiency of an organization based on only those costs management can control.
The EBITDA-to-sales ratio divides the EBITDA by a company's net sales. A ratio equal to 1 implies 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 deduction of those expenses in the numerator. As a result, the EBITDA-to-sales ratio should not return a value greater than 1. A value greater than 1 is an indicator of a miscalculation. Still, a good EBITDA-to-sales ratio is a number higher in comparison with its peers.
EBITDA-to-sales can be construed as a liquidity measurement, because a comparison is being made between the total revenue earned and the residual net income before certain expenses, showing 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.
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 to one another. 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. Finally, the exclusion of debt interest has its drawbacks when measuring the performance of a company. Companies with high debt levels should not be measured using the EBITDA-to-sale ratio since large and regular interest payments should be included in the financial analysis of such companies.