What is the EBITDA margin and why is it useful?

Revolut Contributor

 Β· July 06, 2020  Β· 07/06/2020

The EBITDA margin is a ratio that reveals how much profit a business generates for every pound it makes in revenue, once it deducts specific categories of costs from the total.

The EBITDA (pronounced EE-BIT-DAH) is an acronym that stands for Earnings Before Interest, Tax, Depreciation and Amortisation. As the name suggests, the metric reveals the profits that a business would have made if it did not subtract these costs from its revenue.

This profit margin is a useful way to compare businesses of different sizes without the results being affected by costs unrelated to their core business operations, or based on subjective accounting treatments, such as the decline in value of long-term assets (e.g. depreciation).

πŸ‘‰ All you need to know about EBITDA

How do you calculate the EBITDA margin?

Take the monetary value of the EBITDA of a business over a given period and divide it by the revenue over the same time. The resulting figure is then multiplied by one hundred to convert the basic ratio into a percentage and reveal the EBITDA margin.

EBITDA margin = (EBITDA/Revenue) x100

Unlike some profit metrics, the EBITDA isn't typically calculated directly from total revenue. Instead, you take the net profit and add back specific elements to arrive at the value. This task is simple because the figures are on the income statements of the business.

Do you want a high or low EBITDA margin?

As with any profit ratio, a high margin percentage is preferable. This result shows that the business is more efficient at turning its revenue into profit – or to be more precise, turning its revenue into the EBITDA definition of profit. If the ratio is negative, this indicates the business made a loss in EBITDA terms.

What is a good EBITDA margin?

The great thing about margin analysis is that it enables the direct comparison of different types of businesses. Like most financial metrics, it's more insightful to compare the EBITDA margin to the same metric from earlier periods, a forecast, or an industry benchmark than to define one arbitrary value as 'good'. That's a dangerous game.

Some investors watch the EBITDA margin closely. They think it reveals if a business is profitable without the distorting effects of non-cash factors that managers have less control over. These include taxes due or sums allowed for the decline in the value of long-term assets the business owns. For this reason, the EBITDA and its associated margin are both said to provide insights into the cash position of the business and its ability to service debts.

Critics say this approximation for cash flow is unreliable. That is because the EBITDA ignores changes to working capital, which can create significant cash-drain, especially for a rapidly growing business. They also argue that the EBITDA strips-out so many expenses, it's more realistic to call it 'profits before all the bad stuff'. Either way, it's wise to use the EBITDA margin alongside rivals, such as net profit margin or the EBIT margin to gain a broader view.

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