What EBITDA margin tells you
EBITDA starts from earnings and adds back four items: interest, income tax, depreciation and amortization. Interest depends on how the business is financed, and tax on where and how it is taxed. Depreciation and amortization spread the cost of equipment, buildings, software and other long-lived assets over the years they are used. They reduce profit, but no cash is paid out when they are charged. Revenue is net sales for the same period.
A result of 20% means EBITDA equals 20% of revenue. Interest, tax and spending on new or replacement assets all still have to be paid out of that 20%.
EBITDA is not a standard accounting measure
Neither US GAAP nor IFRS defines EBITDA, so companies choose how to calculate it. The US Securities and Exchange Commission treats it as a non-GAAP measure. In its guidance, “earnings” means net income, a figure with any further adjustments must carry a different name such as adjusted EBITDA, and a company that presents EBITDA in its filings must reconcile it to the most comparable GAAP measure.
This has a direct effect on the margin. Adjusted EBITDA often adds back further items, such as share-based compensation or restructuring costs, so a margin based on it is a different measure and is often higher. EBITDA built up from operating income can also differ from EBITDA built up from net income when a business has non-operating income or expenses. Before you compare EBITDA margins, find out how each EBITDA figure was built.
Reading a high or low result
Because it is measured before depreciation, amortization, interest and tax, EBITDA margin is often used to compare operating performance across businesses with different levels of debt and different amounts invested in long-lived assets.
- A high margin can reflect pricing power or low running costs. In a business that must keep investing in equipment, though, much of that margin may be needed to replace assets as they wear out.
- A low margin means running costs take up most of revenue before any charge for assets, financing or tax. A negative margin means a loss even before those items.
The gap between EBITDA margin and operating profit margin roughly shows how much depreciation and amortization weigh on the business, and it tends to be wider in capital-intensive businesses. What is normal varies by industry, so compare with earlier periods or with similar businesses that define EBITDA the same way.
What the margin does not show
- It is not a measure of cash flow. It ignores spending on new assets, money tied up in inventory and receivables, and the interest and tax the business actually pays.
- It leaves out the cost of using up assets. Equipment wears out and has to be replaced, so that cost is real even though no cash is paid in the year it is charged.
- It hides financing risk. A heavily indebted business can show the same EBITDA margin as one with no debt.
Common mistakes
- Comparing a margin based on adjusted EBITDA with one based on EBITDA, or comparing companies without reading how each defines it.
- Mixing build-ups, such as EBITDA from net income for one business and from operating income for another.
- Treating EBITDA margin as the share of revenue the business keeps as cash.
- Using EBITDA for one period and revenue for another, such as the last twelve months against the last fiscal year.
Related measures
To work out EBITDA itself, from net income or from operating income, use the EBITDA calculator. EBIT vs EBITDA explains what changes when depreciation and amortization are added back. EV/EBITDA compares the value of the whole business, debt included, with the same earnings figure.