Companies use a variety of financial metrics to measure and assess their operating performance. A common method consists of dividing different cost items from the income statement into gross sales and comparing the results over time to assess costs and keep them in line within the company, with its competition and within its industry. Margin analysis represents one category of this type of assessment.
Earnings before interest, tax, depreciation and amortization (EBITDA) and EBITDA margin analysis takes a somewhat high-level look at a company’s performance without getting caught up in individual expense line items on the income statement. It also evaluates a company’s operating performance without needing to factor in any effects of non-cash depreciation and amortization expenses or interest expense from debt financing.
The formula for calculating a company's EBITDA margin is: EBITDA Margin = EBITDA / Total Revenue.
How Do You Calculate EBITDA?
To calculate an EBITDA margin, first you’ll need to calculate EBITDA. You won’t typically find EBITDA as a line item on a company’s financial statement, but you can do an EBITDA calculation to arrive at the number. You can approach this in two ways, and both use numbers from the company's income statement.
You can either start with the firm’s operating income and add back depreciation and amortization, which are both non-cash expenses, or use an EBITDA formula that starts with the company’s bottom-line net income. To the net income figure you would add back taxes, interest, depreciation and amortization.
What Is an EBITDA Margin?
A company’s EBITDA margin measures its EBITDA as a percent of its total revenue. You can use the following formula to calculate a company’s EBITDA ratio or margin:
EBITDA Margin = EBITDA / Total Revenue
For example, say that ABC Widgets, Inc. has annual sales revenue of $1 million and an EBITDA of $30,000. You would calculate its EBITDA margin as follows:
$30,000 / $1,000,000 = 30 percent EBITDA margin
Using this metric can tell you more specific information about a company because it excludes expense items that have little to do with the actual operations of the company.
What’s a Good EBITDA Margin?
A company’s EBITDA margin percentage may change over time and look quite different than margins from companies outside its industry. The percentage could vary widely from one industry to the next. Generally, though, a “good” EBITDA margin would show that the company has a good amount of revenue left over after it pays for all of its operating expenses.
To benchmark a good margin for one specific company, you would calculate the margin for several periods and compare, looking for the time period in which the company had the highest profit amount, which would subsequently reveal its highest EBITDA margin. You would also need to check the same statistic for other companies in the subject’s industry, especially for its competitors, to understand what qualifies as a strong or good margin.
Interpreting the Margin Result
Investors use an EBITDA margin or EBITDA dollar amount as a measure of operating performance. Translating dollar profits into a percentage margin makes it much easier to compare companies within an industry or companies with different debt structures, equipment or tax brackets.
Conversely, an EBITDA margin can downplay certain negative characteristics, such as a heavy debt load or ongoing or frequent spending on expensive equipment. Additionally, some companies that have an EBITDA that differs substantially from their net income may choose to highlight only their EBITDA because it makes them look more profitable.
Generally accepted accounting principles don't specify a certain EBITDA formula to which companies must adhere. This means that investors might make their own decisions about what EBITDA includes, and companies may even choose to include certain items in their EBITDA calculation in one period and not the next.