When a company is trying to determine their operating profitability, they typically use an EBITDA margin - which helps investors, executives and other analysts get a better picture of how well the company is doing. But, what actually is an EBITDA margin and how do you calculate it? Better still, what are some examples?
What Is an EBITDA Margin?
An EBITDA margin is a way a company can assess their operational profitability and efficiency, and is calculated by dividing the company's earnings before interest, taxes, depreciation and amortization by total revenue. An EBITDA margin is typically used to give investors or business owners a better idea of the operating profitability and cash flow of a company, and is represented as a percentage of the company's total revenue.
Unlike other means of measuring profitability, an EBITDA margin takes a kind of bird's eye view of the current state of the company's operations and profitability while avoiding getting into the weeds of individual expense lines.
The "earnings" part of the EBITDA margin comes from things like cost of goods (COGs) and sales general and administrative (SG&A), but doesn't include depreciation or amortization. Depreciation and amortization are the decrease in value of goods over time and the spreading out of payments on loans, respectively.
EBITDA Margin Formula
The EBITDA formula is pretty basic:
(Earnings before interest, taxes, depreciation, amortization)/total revenue
Calculating the EBITDA margin is fairly easy. Simply add the earnings before interest, taxes, depreciation and amortization and divide that total by the total revenue of the company. It is represented as a percentage of that total revenue.
EBITDA vs. Other Profit Margins
But, how is the EBITDA margin different from other profit margins? And why might it be preferable, depending on circumstances?
In corporate accounting, there is a standard called the generally accepted accounting principles (GAAP) which are requirements for all corporate accounting. For example, a profit margin, unlike EBITDA, uses one of the three main principles for GAAP guidelines - gross profit margin, operating profit margin or net profit margin.
The profit margin, which uses the net profit margin, is one of the main ways a company uses the GAAP metrics to essentially evaluate if they are able to turn a profit using their expenses and revenues. Because profit margins are standardized by GAAP, they are generally a good indicator of the company's financial well-being. However, the EBITDA margin operates on a different basis, using more nuanced metrics to help companies evaluate their performance and health. Because it doesn't adhere to GAAP (and is therefore called a non-GAAP metric), EBITDA differs slightly from other profit margins.
Additionally, EBITDA uses slightly different means to measure operational efficiency - for example, unlike GAAP margins, EBITDA uses gross profit - which, for EBITDA calculations, is only comprised of the revenue minus costs related to production of goods for sale. And, operating profit includes depreciation and amortization among other metrics.
For this reason, EBITDA is also different from operating margin (because, unlike operating margin, it includes depreciation and amortization).
EBITDA margins are often used in mergers and acquisitions (M&A) of small companies and large companies because it is an easy metric to use across different industries or sizes of companies.
Pros and Cons of EBITDA Margin
Still, despite it being a non-GAAP metric, there are many pros of using an EBITDA margin (but also some cons too).
The EBITDA margin measures the cash profits a company makes per year. And for investors, viewing the company's EBITDA margin can sometimes provide a better indicator than other profit margins because it downplays the effects of non-operating or other unique depreciation, amortization and tax factors.
For one, using EBITDA can make it easier to compare companies across different industries since it is always represented as a percentage of the total revenue by using the operating profit - which allows investors or analysts to see how well a company is using their operating cash compared to the revenue it generates. By showing the correlation between operating cash flow and revenue, an EBITDA margin is especially helpful for owners to evaluate how well the company is using their resources and operating cash.
Additionally, a company can compare their EBITDA margins over the years to track their progress, as well as compare their efficiency to others (usually bigger companies) in their industry. For example, a small company earning less revenue but with a better EBITDA margin would be more efficient than a large company with a lower EBITDA margin.
So, the main benefit of using an EBITDA margin lies in the fact that it allows owners, investors or analysts to make informed business decisions based on how efficient their operating profit is compared to their revenues.
Still, there are some cons to using an EBITDA.
Some companies can misuse the EBITDA margin in order to make their company seem more profitable, given that the EBITDA excludes debt in its calculations. For this reason, companies who hold a lot of debt and have higher interest payments generally should not use EBITDA to evaluate their efficiency.
Additionally, because the EBITDA margin is typically a bit higher than a profit margin, companies that don't have very high profitability shouldn't use EBITDA either, as it may overestimate their company's position. And, as a non-GAAP metric, EBITDA margins can sometimes be manipulated by companies, which can be dangerous or harmful for investors and analysts.
Even Forbes claimed that the EBITDA was a "Great Big Lie" in 2011 - stating that EBITDA makes asset-heavy companies look better, is selective about debt, ignores working capital requirements and lacks GAAP guidelines.
For these reasons, EBITDA should generally be used alongside GAAP metrics to determine a company's overall health and position.
Examples of EBITDA Margin
Source: Starbucks SEC Filing 2017
To determine the operating efficiency and direct cash flow of the company, Starbucks would use the following lines to determine their EBITDA margin: the "total net revenues," "depreciation and amortization" and "operating income" to find the EBITDA:
EBIT (or operating income) = $4,171.9 + depreciation and amortization = $1,011.4, which equals = $5,146.1 million (the EBITDA). Then, to find the EBITDA margin, simply divide the EBITDA by the total revenues, which come in at $22,386.8 million for 2017.
So, Starbucks' 2017 EBITDA margin is 5,146.1/22,386.8 = 22.98%.
Industries with the Highest EBITDA Margins
Certain industries tend to have really strong EBITDA margins.
Some of the industries that tend to have the highest EBITDA margins include oil, telecom, gas, railroads and semiconductors, to name a few.
Additionally, the alcohol and tobacco industries typically have higher EBITDA margins due to the fact that they are harder to get into because of regulations. And, banks also generally enjoy higher EBTIDA margins because they are typically low non-interest expense.
What Is a "Good" EBITDA Margin?
While a "good" EBITDA margin will usually vary depending on the industry, it is generally one that is a higher percentage, which shows that the company is able to pay off its operating costs and still has a hefty revenue left over. To determine if your company has a "good" EBITDA margin, you should calculate the margin for several periods and compare them.
There are several EBITDA calculators on the internet, which can be useful if you already have your EBITDA number and total revenue.