EBITDA Margin

What is EBITDA Margin?

A company’s EBITDA margin shows the recurring operating profit before the impact of depreciation and amortization as a percentage of sales. It is a measure of profitability and is used as a metric to compare a company’s operating performance from one year to the next, or relative to an industry peer.

An EBITDA margin is a key metric when looking at non-financial companies and has applications in valuation and credit analysis. It takes a step beyond the operating margin and strips out any non-recurring events, as well as accounting for depreciation and amortization.

EBITDA Margin Formula

The margin is calculated as follows:

EBITDA is earnings before interest, taxes, depreciation, and amortization. It can be calculated as:

For many companies, operating profit is equal to EBIT, but analysts will need to check this prior to calculating EBITDA for each company as there may be variations.

This information to calculate the EBITDA margin can be found in the financial statements. Sales (or revenues) figures are reported in the income statement along with operating profit.

The most common source for finding depreciation and amortization is in the cash flow statement under ‘Operating Activities’. It may also appear in the Notes accompanying the financial statements.

Compared to EBIT, EBITDA excludes non-cash expenses such as depreciation and amortization. Companies may have different depreciation and amortization policies for these assets, resulting in a larger (or smaller) expense. This will in turn reduce (or increase) their EBIT. Adding back these expenses can make it easier to compare with competitors.

Example Calculation

Here is an example to show how to calculate EBITDA and EBITDA margin:

We have been provided with an income statement along with additional information in the footnotes. The revenue figure has been provided so we now need to calculate EBITDA.

The calculation should always start at operating profit. Use this as your anchor if you are ever unsure of the next step. In this example it is labelled “Profit before interest and tax”. It may also be labelled as operating profit or EBIT depending on the company’s statements.

Once operating profit is located, analysts must check above and below this line and look for any non-recurring items or items which should be included as part of the operations of the business. Typical examples of non-recurring items would be restructuring costs or one-off items such as fines or compensation. In this example there are none to be added.

Next, we need to check the footnotes for any embedded items which need to be cleaned from the operating profit. The footnote says there is an R&D expense, and a provision related to a legal claim, both included in SG&A. These have already been included to arrive at operating profit, however, a legal claim provision is not part of the operations of the business and must be added back. R&D are expenses related to the discovery of new technology and are ignored for this calculation.

This provides the following analysis:

Revenues are reported at the top of the income statement and can be referenced in the calculation of EBITDA margin. Using this method, we can determine that this company has an EBITDA of 1,119.7 and an EBITDA margin of 30.7% for the time period.

It is important to note that margins should always be compared to an industry benchmark or a comparable company or over a period of time. Standalone figures provide only a snapshot and are in some way meaningless without an appropriate comparison. A year-over-year comparison would be helpful to show if the margin was improving, declining, or remaining unchanged.

Download the Financial Edge EBITDA margin template to enable you to work quickly through EBITDA and margin calculations. Take the underlying data and follow the steps to complete the analysis. The template enables you to compare performance year-over-year; if the EBITDA margin is rising, this would suggest the business’ operations are improving.

Applications of EBITDA Margin

Valuation

Key metrics are calculated for industry peers and are used to extrapolate the value of the business being considered. EBITDA margins, along with other operational  such as gross margin, EBIT margin, and net margin, are useful for comparison to peers.

EBITDA margins are particularly helpful when analyzing a business’ underlying operational performance whilst it is undergoing restructuring as reported data may not reflect this. The metric focuses on the normalized EBITDA which is a useful comparative versus historical performance and also relative to peers.

As a rule of thumb, a company that is growing and improving its performance should have an increasing EBITDA margin. If an EBITDA margin is deteriorating over time, it suggests that there may be some operational issues at the company which require further analysis.

When looking at a sector it is easy to create a sector average using the margin data from each company. Some companies may consistently deliver an EBITDA margin above or below this average. Further analysis is required to determine why – its typically due to the mix of product, customer or pricing power that a company has within the sector. For example, a company which delivers a value-based product (rather than a premium product) will typically have a lower pricing structure, resulting in lower profits as a percentage of sales. Alternatively, a lower-than-the-sector average EBITDA margin could be related to the operating structure of the business as it may for example spend more on its raw materials or staffing costs.

Credit Analysis

Lenders and credit rating agencies look into several factors before giving a loan or assigning a credit rating to a company. EBITDA margins are one of the factors considered in credit analysis. Decreasing EBITDA margins can negatively affect the creditworthiness of a borrower.

Conclusion

EBITDA margin is a useful financial tool to gauge the operational performance of a company. Having stripped out non-recurring items, analysts are able to use EBITDA margins to consider whether the underlying performance of the company or business units is improving or deteriorating. It is particularly useful for manufacturing and producing companies or those with notable depreciation & amortization costs. EBITDA margin is not typically used for financial companies.

Additional Resources

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