One way to measure your business’s profitability is to calculate its EBITDA margin. EBITDA stands for earnings before interest, taxes, depreciation, and amortization, and is used to assess a company’s operating performance. EBITDA margin compares a company’s EBITDA to its total revenue and is expressed as a percentage. The higher the EBITDA margin, the smaller a company’s operating expenses are in relation to their revenue, resulting in a more profitable enterprise.
EBITDA margin is often used as an alternative to standard measurements of profit margin. Proponents of EBITDA margin believe it offers a more accurate reflection of financial operations, since it removes the influence of expenses that may hide how a company is truly performing.
Read on to learn the EBITDA margin formula, why this accounting metric is important to know, and exactly what it can tell you about your small business.
Key Points
• EBITDA margin measures operating profit as a percentage of revenue, indicating a company’s financial efficiency.
• Like EBITDA, it looks at how well a business is doing before external influences like capital structure and taxes are factored in.
• EBITDA margin can be useful for comparing profitability across companies of different sizes within the same industry.
• Business owners can use EBITDA margin to assess profitability trends and compare against industry standards.
• EBITDA margin is not accepted by GAAP, and can sometimes be misleading
What Is EBITDA Margin?
To fully understand the EBITDA margin, you need to first understand EBITDA (earnings before interest, taxes, depreciation, and amortization). EBITDA is similar to net income except that it adds back certain expenses, including interest on any small business loans, income taxes, and non-cash depreciation and amortization costs. The purpose of adding these costs back to net income is to remove the factors that business owners have control over, such as debt financing, capital structure, methods of depreciation, and taxes (to some degree).
The EBITDA margin is a measure of a company’s operating profit shown as a percentage of its revenue. Like other margin ratios, EBITDA margin gives insight into a company’s ability to turn sales into a profit. It looks specifically at how well a business is doing before external influences like taxes are incorporated.
EBITDA Margin Formula
To calculate EBITDA margin, you divide the EBITDA number by total sales revenue. Here’s the formula:
EBITDA Margin = EBITDA / Total Revenue
How Does EBITDA Margin Work?
The EBITDA margin tells you how much operating expenses are eating into your company’s gross profit. In other words: It reveals what percentage of each dollar earned in revenue is making its way into EBITDA. Generally, the higher the EBITDA margin, the less risky a company is considered financially. For this reason, a good EBITDA margin can make it easier to qualify for financing with favorable rates and terms.
EBITDA margin is also used by investors and analysts to compare the relative profitability of two or more companies of different sizes in the same industry. It’s important to note, however, that EBITDA margin is considered a non-GAAP financial figure, meaning it does not follow generally accepted accounting principles (GAAP).
EBITDA Margin Calculation
To calculate the EBITDA margin, you must first calculate EBITDA. You do this by taking your company’s net income then adding back taxes, interest expenses, and depreciation/amortization costs. Alternatively, you can calculate EBITDA by starting with your firm’s operating income (or EBIT), then adding back depreciation/amortization.
These formulas look like this:
EBITDA = Net Income + Taxes + Interest Expense + Depreciation/Amortization
or
EBITDA = Operating Income + Depreciation/Amortization
Once you know the EBITDA number, you divide it by total sales revenue to come up with EBITDA margin.
Uses of EBITDA Margin & What It Tells Us
EBITDA margin tells you how efficiently a company is converting revenue into earnings (before interest, taxes, and depreciation/amortization are subtracted). If a company has a high EBITDA margin, it means that its operating expenses are lower in relation to total revenue. This can make it easier to qualify for many types of small business loans.
As a business owner, it can be useful to compare your company’s EBITDA margin to the EBITDA margins of previous periods in order to see any trends in profitability and/or gauge the effectiveness of cost-cutting efforts. You can also compare your company’s EBITDA margin to the industry standard. Generally, having a higher EBITDA margin compared to your competitors indicates that your company is producing higher profits from its core operations.
Analysts, investors, and lenders also use EBITDA margin to determine a company’s stability and long-term profitability. In addition, they may look at a company’s Debt/EBITDA ratio, which measures a company’s ability to pay off its current debt load.
EBITDA Margin vs EBITDA Compared
| EBITDA Margin | EBITDA |
|---|---|
| A percentage | A nominal figure |
| Divides EBITDA by revenue | Shows earnings before interest, taxes, depreciation, and amortization |
| A metric of operating efficiency | A metric of operating efficiency |
Pros and Cons of Using EBITDA Margin
| Pros of Using EBITDA Margin | Cons of Using EBITDA Margin |
|---|---|
| It reveals how much operating cash is generated for each dollar of revenue earned. | It can be used to draw attention away from a company’s debt and enhance the perception of its financial performance. |
| It offers a simple way to compare a company’s performance to its peers. | It can vary significantly by market and industry, so not helpful when comparing companies in different industries. |
| It can help a business gauge the effectiveness of their cost-cutting efforts. | It is not regulated by GAAP. |
Alternatives to EBITDA Margin
EBITDA margin is one of many ways to calculate your business’s profitability and operational efficiency. Here are some others you may want to use.
EBITA
EBITA is earnings before interest, taxes, and amortization. It’s an alternative to EBITDA that does not back out depreciation. EBITA is used more commonly with firms that do not have large amounts of capital expenditures that might result in high depreciation expenses. Like EBITDA, EBITA is a non-GAAP performance metric.
EBIT
EBIT is earnings before interest and taxes. Like EBITDA, EBIT adds interest and taxes back to net income. However, EBITDA takes EBIT a step further by also adding back the non-cash charges of depreciation and amortization. If a company has high interest costs, it might choose EBIT over net income as a performance indicator. A capital-intensive company or one with substantial intangible assets (and amortization expenses), on the other hand, might go with EBITDA, since EBIT could make it look like the firm was incurring steep losses when, in fact, those were non-cash expenses.
Operating Margin
Like EBITDA margin, operating margin is a profitability ratio that owners, investors, and analysts use to evaluate a company’s ability to turn a dollar of revenue into a dollar of profit after accounting for expenses. Both operating margin and EBITDA margin measure a company’s profit after paying variable costs, but before paying interest or tax. EBITDA, however, also excludes depreciation and amortization expenses. Another difference is that EBITDA is not accepted by GAAP, while operating margin is.
Recommended: EBITDA vs Gross Profit: Differences and Similarities
EBITDA Margin Example
Let’s look at an example of how to calculate a company’s EBITDA margin.
Company XYZ
Revenue: $5 million
Net income: $500,000
Interest expenses: $50,000
Taxes: $80,000
Depreciation and amortization expenses: $60,000
EBITDA = $690,000 (net income + interest, taxes, depreciation, and amortization)
EBITDA margin = $690,000/$5 million = 13.8%
Recommended: Reinvest Business Profits
The Takeaway
EBITDA margin is a measurement of operating profit as a percentage of revenue. It is calculated by dividing EBITDA by revenue and expressed as a percentage. The EBITDA margin formula is commonly used to compare business performance across firms within the same industry. Lenders might also use EBITDA margin, along with other metrics, to assess the financial health of a small business applying for a loan. Business owners can use EBITDA margin to compare profitability from one accounting period to another and run their businesses more efficiently.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What is considered to be a good EBITDA margin?
What’s considered a good EBITDA (earnings before interest, taxes, depreciation, and amortization) margin will vary by industry, as well as the size and growth stage of a business. But generally speaking, you want your company’s EBITDA margin to fall between 15% and 25%.
What’s the average EBITDA margin of businesses?
EBITDA (earnings before interest, taxes, depreciation, and amortization) margins vary by industry. So the best way to know how you stack up against your peers is to compare your company’s EBITDA margin to the average for your industry.
What’s the difference between EBITDA and EBITDA margin?
The difference between EBITDA (earnings before interest, taxes, depreciation, and amortization) and EBITDA margin is simply that EBITDA is a nominal earnings metric, while EBITDA margin presents earnings as a percentage of revenue.
Photo credit: iStock/LuckyBusiness
SoFi's marketplace is owned and operated by SoFi Lending Corp. See SoFi Lending Corp. licensing information below. Advertising Disclosures: SoFi receives compensation in the event you obtain a loan through SoFi’s marketplace. This affects whether a product or service is featured on this site and could affect the order of presentation. SoFi does not include all products and services in the market. All rates, terms, and conditions vary by provider.
Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.
This content is provided for informational and educational purposes only and should not be construed as financial advice.
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
SOSMB-Q424-058