What is EBITDA Margin?
The EBITDA Margin (%) measures a company’s core operating efficiency and is calculated as EBITDA divided by revenue in a given period, expressed as a percentage.
How to Calculate EBITDA Margin (Step-by-Step)
As we’ve described earlier, the EBITDA margin is the ratio between EBITDA and revenue.
While revenue is the starting line item on a company’s income statement, EBITDA is a non-GAAP metric intended to represent a company’s core profitability on a normalized basis.
So in short, the EBITDA margin answers the following question, “For each dollar of revenue generated, what percentage trickles down to become EBITDA?”
To calculate the EBITDA margin, the steps are as follows:
- Step 1 → Gather the revenue, cost of goods sold (COGS), and operating expenses (OpEx) amounts from the income statement.
- Step 2 → Take the depreciation & amortization (D&A) amount from the cash flow statement, as well as any other non-cash add-backs.
- Step 3 → Calculate the operating income (EBIT) by subtracting COGS and OpEx from revenue, and then adding back D&A.
- Step 4 → Divide the EBITDA amounts by the corresponding revenue figure to arrive at the EBITDA margin for each company.
But before we delve deeper into the metric, review the primer on EBITDA to ensure the profit metric is fully understood.
Understanding EBITDA: Quick Concept Review
In order to understand the importance of a company’s EBITDA margin, it is critical first to understand the importance of EBITDA – an abbreviation for the term, “Earnings Before Interest, Taxes Depreciation and Amortization” – which is perhaps the most ubiquitous measure of profitability in corporate finance.
EBITDA reflects the operating profits of a company, i.e. revenue less all operating expenses except for depreciation and amortization expense (D&A). Because EBITDA excludes D&A, it is a measure of operating profits that is undistorted by an often large non-cash accounting charge in each period.
When compared to the amount of revenue generated, the EBITDA margin can be used to determine the operational efficiency of a company and its capacity to produce sustainable profits.
Learn More → EBITDA Quick Primer
EBITDA Margin Formula
The formula for calculating the EBITDA margin is as follows.
For instance, suppose a company has generated the following results in a given period:
- Revenue = $10 million
- Cost of Goods Sold (Direct Costs) = $4 million
- Operating Expenses = $2 million, which include $1 million of depreciation and amortization expenses
In this simple scenario, our company’s margin is 50%, which we computed from $5 million in EBITDA divided by the $10 million in revenue.
What is a Good EBITDA Margin?
EBITDA margin provides a picture of how efficiently a company’s revenue is converted into EBITDA. In practice, a company’s EBITDA margin is usually used to:
- Compares against its own historical results (i.e. profitability trends from the previous periods)
- Compare vs. competitors in the same (or relatively similar) industries
For comparisons of any profit margin to be more useful, the companies chosen as part of a peer group should operate in the same industry, or in adjacent ones with similar performance drivers, in order to take into account industry-specific factors.
Generally speaking, higher EBITDA margins are perceived more favorably, as the implication is that the company is producing a higher amount of profits from its core operations.
- Higher EBITDA Margins: Companies with higher margins relative to the industry average and vs. historical results are more likely to be more efficient, which increases the likelihood of gaining a sustainable competitive advantage and protecting profits over the long term.
- Lower EBITDA Margins: Companies with lower margins compared to peers and declining margins could point to a potential red flag, as it implies the presence of underlying weaknesses in the business model (e.g. targeting the wrong market, ineffective sales & marketing).
Learn More → EBITDA Margin by Sector (Damodaran)
EBITDA Margin vs. Operating Margin: What is the Difference?
While the EBITDA margin is arguably the most commonly used profit margin, there are others, such as the following:
EBITDA margin’s closest cousin is the operating margin, defined as EBIT/Revenue, where EBIT is defined as the revenue less ALL operating expenses (including D&A).
The critical difference between the EBITDA and operating margin is the exclusion (i.e. in the case of EBITDA) of depreciation and amortization. Practically speaking, that means that for a company that has D&A expenses, the operating margin will be lower in comparison.
The operating profit (EBIT) is an accrual GAAP measure of profit, whereas the EBITDA metric is a GAAP/cash hybrid profit margin.