EBITDA stands for Earnings Before Interest, Taxes, Depreciation and Amortisation. It is a measure of the operating income of a firm before providing for interest expenses, taxes and depreciation or amortisation charges.
EBITDA Margin is the measure of a company’s EBITDA as a percentage of its revenue. It is calculated as follows:
EBITDA Margin = EBITDA / Revenue
Why is EBITDA Margin useful?
EBITDA Margin is a way of telling how efficient a company is in turning its Revenues into profits from operations (i.e before providing for interest, taxes and depreciation).
Revenue is the sales turnover of the company.
Since, revenue less operating costs give us the operating profits, a company with higher operating costs will have a lower operating margin than others.
EBITDA margin can be a useful tool in comparing the operational efficiency of companies operating within the same industry – the company with the highest margin being the most efficient in managing its operating costs.
It is important to note here that off the companies being compared, the one with the highest EBITDA margin may not necessarily be the most profitable. This is because EBITDA does not take Interest expenses into account.
A company with a higher proportion of debt in its capital structure will have a greater liability in terms of interest expenses and its ultimate profitability will depend upon how large this interest outgo is.
Also note that, EBITDA margin cannot be used in comparing companies across industries because the nature of operating costs will differ from Industry to Industry.
Treatment of Non Operating Income:
Note that apart from revenue from operations, the total revenues figures may include earnings from non-operational investments (like fixed deposits and investments in shares and mutual funds). These earnings are not generated from the core operating activities of the entity.
To have a meaningful comparison of EBITDA margin of different companies operating within the same industry, we may exclude this non-operational income from both the numerator (i.e EBITDA) and denominator (i.e Revenue) to focus only on the operational income.