What Is an EBITDA Margin? (Plus 4 Steps To Calculate It)

By Indeed Editorial Team

Published September 15, 2021

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

To monitor the health and growth of your organization, it's important to understand different metrics that can help you. Businesses use EBITDA to help them understand their financial health and the health of their competitors. By using metrics like an EBITDA margin, financial advisers can develop business strategies and make informed decisions about their business processes. In this article, we discuss what is an EBITDA margin, including the formula, how you can find your EBITDA margin and the advantages and disadvantages of using this metric.

Related: 12 Quantitative Metrics To Help Measure Business Performance

What is an EBITDA margin?

An EBITDA margin is a metric that businesses use to measure how much revenue they are earning in a specific period before certain expenses. This metric helps companies compare operating profits. The higher an EBITDA margin is, the lower your operating expenses are, and low operating expenses come with the possibility of higher profit.

EBITDA doesn't measure a company's actual profit because the company still has to pay the expenses that the EBITDA doesn't subtract. Therefore, companies don't share this metric on accounting or financial documents with shareholders or banks. It's used to inform business strategy and help businesses understand their performance compared to other companies.

The acronym stands for earnings before:

  • Interest: This is a fee paid to lenders and shareholders to compensate for loans or investments.

  • Taxes: Taxes are fees paid to local, state and federal governments for shared government services.

  • Depreciation: This is the loss of an investment's value over time.

  • Amortization: This represents paying off debts or the acquisition of assets with regular payments.

These are all common and often necessary expenses for a business. However, you can compare a company's income profit with the operating expenses without subtracting these expenses from your total profit. This can help you understand how their operating processes affect their profit.

Read more: What Is EBITDA?

What is the EBITDA formula?

The EBITDA formula is:

EBITDA = net income + interest expenses + tax + depreciation + amortization

The EBITDA margin is usually a percentage found using the formula:

EBITDA ÷ total revenue = EBITDA margin

How to calculate the EBITDA margin

You can follow these steps to calculate the EBITDA margin of two companies and compare them:

1. Find the total revenue

The first thing you need when calculating the EBITDA is to find the total revenue for your company and your competitor. You can find that information by adding up all your sales for a particular period. If you're making a financial projection, you can multiply your expected number of sales by the average price of service or sales. You can typically find this information, along with the other information you may need to find your EBITDA margin, on the income statement.

For example, if you're comparing two companies, their income statements may look like this:

Your company
Total revenue: $2,000,000
Cost of labor: $300,000
Cost of materials: $700,000
Interest ($200,000 loan at 15%): $30,000
Taxes (30%): $300,000
Depreciation: $1,000
Amortization (payment on new building): $10,000
Net income: $659,000

Competitor company
Total revenue: $2,000,000
Cost of Labor: $300,000
Cost of materials: $200,000 Interest ($500,000 loan at 10%): $50,000
Taxes (30%): $450,000
Depreciation: $3,000
Amortization (payment on new building): $30,000
Net Income: $967,000

Read more: How To Calculate EBITDA (With Examples)

2. Subtract the operating cost

Once you have the total revenue, you can subtract the costs of operation, which include the costs of goods sold (COGS), like:

  • Materials

  • Production labor

  • Cost of shipping materials

Operating costs also include selling, general and administrative (SG&A) expenses, including:

  • Rent

  • Utilities

  • Office supplies

  • Legal costs

  • Sales and marketing

  • Insurance

Once you've subtracted these costs, you have your earnings before you subtract interest, depreciation, taxes and amortization. This revenue is the number you can use to find your EBITDA margin. The comparison may look like this:

Your company Revenue: $1,000,000
Interest ($200,000 loan at 15%): $30,000
Taxes (30%): $300,000
Depreciation: $1,000
Amortization (payment on new building): $10,000
Net income: $659,000

Competitor company
Revenue: $1,500,000
Interest ($500,000 loan at 10%): $50,000 Taxes (30%): $450,000
Depreciation: $3,000
Amortization (payment on new building): $30,000
Net Income: $967,000

If you're working backward from your net income, you can use the formula above. Add your interest, taxes, depreciation and amortization to your net income to find your EBITDA. Using this example, the EBITDA would be:

Your company $1,000,000 = $659,000 + $30,000 + $300,000 + $1,000 + $10,000

Competitor company

$1,500,000 = $967,000 + $50,000 + $450,000 + $3,000 + $30,000

Read more: 10 Examples of Operating Costs in Business

3. Divide by total revenue

You can format your EBITDA as a percentage to make it easier to compare to the margins of your competitors. To find your EBITDA margin percentage, you can divide the EBITDA by your total revenue. For example:

Your company $1,000,000 ÷ $2,000,000 = 50%

Competitor company
$1,500,000 ÷ $2,000,000 = 75%

Related: Total Revenue vs. Marginal Revenue: What's the Difference?

4. Compare to competitors

Once you have your margin, you can compare it to your competitors to understand your organization's financial standing compared to other businesses in the same market. Here are some important things your EBITDA margins can show you about your company in comparison with your competitors:

  • Operating costs: A high EBITDA margin means that your operating costs are a low percentage of your overall revenue, and you can use the remaining revenue to reinvest into your company or pay out to shareholders.

  • Profit generation: Your net income can be technically lower than your competitors, but if you have a higher EBITDA, that means that you can make a higher profit. This is appealing to investors because it shows that their returns may be higher with your business than your competitors' companies.

  • Location: When you look at your revenue before tax, you can compare the profits of two companies regardless of location because their state and local tax rates don't affect the figure.

  • Investment: Your depreciation and amortization are numbers concerning your own investments in your company and have no bearing on the profitability of your company. By leaving them in, you can see that your growth isn't impacted by previous investments.

In the above example, your company has the same revenue as its competitor but a lower EBITDA margin. This is because you spend more on your operating costs than your competitor, and it limits your profit generation. Investors may see your competitor as a better investment because it has a higher EBITDA margin and a higher net income. When reevaluating your business strategy to cut costs, you can continue to calculate your EBITDA margin to monitor how much closer you get to your competitor without missing interest payments or selling off your investments.

Read more: How To Conduct Competitor Research

Advantages to using an EBITDA margin

The EBITDA is a tool that businesses and investors use to find specific information about a company's health. Knowing your EBITDA can bring the following advantages:

Informs companies about their financial health

The EBITDA helps business owners and potential investors get an understanding of how much cash is being generated by a company in a particular period. A company uses that cash to invest in its own growth. Understanding how much cash inflow it has, regardless of its previous investments, can help the business understand its profitability. The EBITDA can determine whether a company's business processes are bringing in cash and if current investments have increased the company's profitability, regardless of the additional cost of amortization or depreciation.

Related: Financial Reports vs. Financial Statements: Key Differences

Provides information to investors

When a company is looking to pitch itself to investors, it can use its EBITDA to show its profitability, regardless of its size, location or current debt. A startup may not show a strong net income because so much of their income is going toward paying for newly acquired space or paying off loans. However, they can still show their strength and potential as a startup by calculating their EBITDA. With a high margin, they can persuade investors of their earning potential and prove customer demand for their product.

For example, if an investor is looking at two different companies, one company may have higher revenue than another. However, if their EBITDA margin is low, the investor can see that the first company may not have the same potential in terms of return on the investment. With more information, they can judge that the second company with lower revenue and a higher EBITDA margin has a better business model, making it a safer investment.

Related: Business Metrics: Definition, Examples and Formulas

Measures cost-cutting endeavors

If a company has decided that its business processes are too expensive to be sustainable, it can cut costs and judge its progress with its EBITDA. When they cut costs, their profits may fluctuate, but they can see the true effect of their efforts by calculating their EBITDA.

For example, if a company wants to reduce costs, they may move production to a factory closer to their headquarters to cut down on shipping costs. If their new factory has smaller production capabilities, at first, they may sell fewer products while they renovate the factory. As long as their EBITDA shows that they've saved more on shipping than they've lost on fewer sales, they know they're moving toward increasing their profits. They can periodically check their EBITDA after making each change to judge whether they're making the right decisions for a healthy business.

Read more: Why EBITDA Is Important for a Business (With Example)

Challenges to using an EBITDA margin

EBITDA is a useful tool for internal decision-making, but it's only part of the overall analysis of a company's health. Here are some potential challenges you may face if you rely on your EBITDA margin to predict the success of your business:

Deemphasizes debt

The EBITDA doesn't account for the debt a company has incurred, which can affect the valuation of a company. A company may rely on its EBITDA to determine its financial health and miss the dangers of incurring too much debt. You can avoid this by calculating your debt and weighing it against your EBITDA margin, along with other important factors, like net income and total revenue. While understanding how your operating costs affect your business is important, when making financial decisions about your financial health, you can rely on other measurements as well to get a more complete understanding.

Related: Operating Income vs. EBITDA: Definitions, Examples, Differences

Doesn't follow the generally accepted accounting principles (GAAP)

The generally accepted accounting principles are the commonly held rules that accounting and financial professionals use to report information about a business. These rules ensure that incomes statements, shareholder reports and taxes are all presented accurately and consistently from one organization to another. The GAAP doesn't regulate EBITDA, so this figure can be inconsistent from one organization to another or misrepresent information. To minimize this possibility, most people don't use their EBITDA margins on official documents. Rather, it's a figure used internally by the company or its investors to gather information and make strategic decisions.

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