What is EBITDA margin?
Earlier, we understood everything about Gross Profit Margin ratio. Now, let us put our focus on yet another important profitability ratio – EBITDA margin (pronounced EE-BIT-DAH)
EBITDA margin helps us in evaluating two or more companies irrespective of their Tax Structure or Capital Structure.
Although Operating Profit Margin is used to understand the operating profitability, EBITDA margin gives better idea.
This ratio is used by almost all the stakeholders- including the Analysts, Investors, Lenders, Business Managers etc.
As part of this resource, let us understand the meaning of this margin, learn how to calculate it, know its importance and drawbacks. Also, in the later section, we compare the margin profile for companies from diverse sectors.
EBITDA margin meaning
Just like any other profitability measure, even this ratio explains the profitabilability of the cmopany based on Sales. EBITDA margin basically indicates the operating profitability of the company.
It explains how much EBITDA does the company makes on each dollar of Sales.
If the ratio is higher, it indicates the company is doing Operationally exceptional.
Formula for EBITDA margin
The formula for the EBITDA margin is quite simple.
We take EBITDA in the numerator and Net Sales in the denominator.
Before understanding about EBIT margin, let us quickly understand what is meant by EBITDA.
Although a more detailed explanation about this financial measure is covered in this resource, we try to refresh a few high-level aspects here so that rest of the discussion becomes easier.
What is EBITDA?
EBITDA refers to Earnings before Interest, Taxes, and Depreciation & Amortization. It is one of the most widely used operating profitability measure.
It basically indicates how profitable is the company at the operational level. Since it is calculated without detecting Interest, Taxes, and depreciation, it is often considered as a better comparison tool across industries.
There are many ways to calculate the EBITDA, but in this resource we will discuss two important ways.
- EBITDA from EBIT
- EBITDA from Net Income
Method 1: Calculating EBITDA from EBIT
As highlighted in the image above, EBITD can be calculated from EBIT.
All we need to do is add back any non cash charge like depreciation and amortization to the EBIT.
EBITDA = EBIT + Depreciation & Amortization
Method 2: Calculating EBITDA from Net Income
EBITDA can also be calculated from Net Income. The logic remains the same.
We need to start from Net Income and then adjust all the intermediary items to reach EBITDA.
We begin with Net Income and then add Interest Expenses, add Income Taxes and then finally we add Depreciation and Amortization being a non cash charge.
EBITDA = Net Income + Interest Expenses + Income Taxes + Depreciation & Amortization
Below image highlights the standard way of arriving at EBITDA starting from Revenue.
Now that we have a better idea about EBITDA, we are now in the position to understand EBITDA margin.
Like any other profitability ratio, even this ratio is calculated as a percentage of Sales.
Important consideration while including Sales in the denominator
- Both, cash sales and credit sales should be included as part of Sales.
- Any refund, discount, taxes have to be reduced from Gross Sales to arrive at Net Sales.
- Any unusual or non-operating revenue (Other Income, Misc Income) should not be included.
Let us look at our first example and understand how to calculate EBITDA margin.
Steps to calculate EBITDA margin with example
Let us take hypothetical Income Statement for two companies – Alpha Inc. and Beta Inc.
The financial numbers given in the below are in $ million.
To calculate EBITDA margin we need
- Net Sales
Let us calculate the ratio for both the companies one by one.
From the Revenue, we reduce all the expenses (except Interest, Income Tax and Depreciation & Amortization) to arrive at EBITDA
Alpha Inc : $4,000 – $1,000 – $400 = $2,600
Beta Inc : $3,000 – $1,500 – $500 = $1,000
Net Sales for both the companies can be obtained from the Income Statement.
Alpha Inc: Net sales = $4,000
Beta Inc: Net sales = $3,000
Now that we know both the values, we can easily calculate the ratio.
EBIT margin = (EBITDA / Sales) * 100
Alpha Inc : ($2,600 / $4,000 )* 100 = 65%
Beta Inc: ($1,000 / $3,000) * 100 = 33%
What this indicates is that Alpha Inc. earns $65 of EBITDA on $100 worth of Sales.
Since EBITDA does not deduct non-cash expenses like Depreciation & Non-Operating Expenses like Interest expenses, this profitability ratio is a better measure.
Similarly, Beta Inc. earns only $33 EBITDA on $100 worth of Sales. The company may have a favorable tax structure (leading to low-tax expenses) or low Debt (leading to low-interest expenses) and thereby leading to overall better net profit margins. But at an operational profit level, it is performing relatively bad.
EBITDA margin using Excel for Walmart Inc.
Now, let us look at an example on how to calculate the ratio using Excel.
You can download this template using the below option.
Once you download the file, you will be presented with the above given Consolidated Income Statement of Walmart Inc.
Similar to what we have already calculated in our hypothetical example above, lets us calculate EBITDA and Net Sales for the company.
EBITDA can be calculated by reducing all expenses from revenue (except the Depreciation and Amortization, Interest expenses, and Income taxes).
As highlighted in the image above, EBITD can be calculated as below.
EBITDA = Revenue – Cost of Sales – SG & admin expenses
= $523,964 – $394,605 – $97,804 = $31,555
Now, Net Sales for the company can be easily obtained from the Income Statement.
Net Sales = $523,964
Now that we have both the numerator and denominator, we can calculate the ratio in Excel.
EBITDA margin =EBITDA / Net Sales
= $31,555 / $ 523,964
As evident from the calculation above, Walmart earns a moderate EBITDA margin of only 6%.
What this means is that, Walmart generates $5 as EBITDA on $100 worth of sales.
This value does not detect Interest Expense, Taxes, and Depreciation. Hence, this can be considered as a better comparison tool with other similar companies.
Also, we need to look at the margin profile of other similar companies in the industry before concluding if 6% is good or bad.
Importance of EBITDA margin
- It is very simple and easy to calculate
- As a profitability measure, it does not include Tax expenses, Interest expenses, and Depreciation
- Especially startups who suffer losses use EBITDA as a performance metric at an operational level.
- Even Lenders, Bankers prefer using this profitability metric since it is like a proxy for cash flow (since all other non-cash expenses added back)
- It is neutral to the Capital structure, Tax structure, and Capital intensive businesses. Hence prove to be a better comparison tool.
- It is a non-GAAP measure. Hence, analysts can very much use it for their analysis by making necessary adjustments.
- Since it does not include non-cash expenses, we can understand if the company is performing operationally well.
Drawbacks of EBITDA margin
- Since it is a non-GAAP measure, many companies often try to report adjusted EBITDA to depict higher Profit Ratios.
- Relying solely on EBITDA is not a good idea since companies may have skewed Capital structure and/or Tax structure leading to totally different bottom-line margins.
- For Capital-intensive companies, Depreciation and amortization is a significant expense. Such companies may be better at the EBITDA level. But, as we look at the complete picture, they may be earning lower Net Profit margins.
- Similarly, Debt heavy companies may look operationally profitable at the EBITDA level. Once we factor in Interest expenses, the situation might be totally opposite.
EBITDA margin – Case study
Any financial ratios should be evaluated based on its historical trend.
To get a better idea, margin profile of similar companies in the same industry has to be looked into.
Throughout the next few sections, we try to understand the EBITDA margin profile for companies in various industries (ranging from Tech to Retail and many more)
If you look at the margin profile for Tech companies like Apple, Google, Microsoft, and Facebook, all of them have a decent EBITDA margin which is well about 20%.
The EBITDA margin for Apple has been gradually falling for the past 5 years.
In the year 2015, it was as high as 35%. Since then, every year the company is reporting a fall in its margin. Currently, for the year ending 2019, the margin for the company is around 28%.
The search engine and Ad industry giant Google also makes a healthy EBITDA margin of around 34%. As evident from the chart above, the margin profile looks quite volatile for the past few years.
Although the company reported only a 25% margin for the year 2018 it was able to increase it back to 28% in 2019.
As evident from the chart above clearly Microsoft is successful in increasing its margin over the past few years.
Back in 2015 the margin was around 25%. Suddenly in 2016 due to structural changes around pricing and cost, the company was able to increase its EBITDA margin to almost 35%. Since then company has been successful in increasing the margin even further.
Currently the margin profile is at its peak i.e. around 44%.
Clearly, among all the Tech companies discussed as part of this study, Facebook has the highest margin. It is important to recall that at a Gross Profit margin level itself, Facebook earns a whopping 70%.
Baring the past couple of years, Facebook is successful in increasing its EBITDA margin from 45% to its peak of almost 57%.
Nonetheless for the year ending 2019, the company’s EBITDA margin is at 42%.
As we move our discussion towards Retail companies, the margin profile is not similar. Companies like Walmart earn a very minimal EBITDA margin.
In the example above we calculated the margin for Walmart and it turned out to be around 6%
The margin profile for the US based retail company has been falling over the past few years which is a matter of caution.
Similar to Microsoft even Amazon has made tremendous job in expanding its margin.
Inspite of offering a very diverse range of products and services, the company is able to focus on its business mix and expand its margin over the past few years.
For the year ending 2015, the EBITDA margin was in the range of 8%. This is currently at around 13% more than 60% jump in just 5 years.
Home Depot Inc.
Yet another US based company Home Depot relatively earns better margin than that of Walmart.
Also the company is gradually improving its margin over the past few years.
Currently the margin for Home Depot is around 16%
In the case of US automaker Tesla, the EBITDA margin improvement has been phenomenal.
The company was earning negative EBITDA in the year 2015. From -7% in 2015, the company steadily became EBITDA positive in 2016. Further, it was also able to improve its margin profile in the past 5 years.
Currently, for 2019, Tesla has an EBITDA margin of 9%. Going forward it needs to be looked at if the company would be able to improve its margin profile.
ExxonMobil is a US-based Oil Company. The company makes a EBITDA margin in the range of 13 to 15%.
Over the past 5 years, the company was able to improve its margin. Although the company may have increased its EBITDA margin, the net profitability of the company has been falling for the past 5 years.
Johnson and Johnson Inc.
As we look at the performance of Johnson and Johnson, the EBITDA margin is in the range of 30% to 34%.
For the past few years, there has been a fall in the ratio. For the year ending 2015, it was as high as 34%. But it has fallen to 30% for the year 2019.
Our next company Paypal has a whopping 45% EBITDA margin. Although the margin fell back to 42% in the year 2018, the company managed to increase it back to more than 45%.
With the steady-state increasing EBITDA margin, the company was able to translate it into a better Net Profit margin. Also, the company’s EPS has been increasing for the past few years.
In this resource, we understood everything about EBITDA and EBITDA margin.
Although this margin is a very simple and powerful tool, over-dependence should be avoided.
Similar to any other profitability ratio, even this ratio should not be viewed in isolation.
Any financial ratio will make sense only if it contributes to the overall story.
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