The earnings before interest, tax, depreciation and amortisation (EBITDA) margin is a way of measuring profit. It is a useful metric because it provides business owners with a clearer picture of how good their company is at making and selling goods while keeping costs down.
“EBITDA margin is the most fundamental insight of the business,” says Ollie Gold, Founder and CEO of Popham’s Bakery, a London-based artisan bakery, restaurant and craft shop. “It tracks your performance and gives you clarity on how the business is doing and how you compare month-to-month and year-to-year.”
What is the EBITDA margin and how to calculate it?
EBITDA stands for earnings before interest, tax, depreciation and amortisation. It measures the amount of money a business makes from selling its goods, before non-operating expenses like interest on debt, or taxes, are deducted. It usually sits on the balance sheet after gross profit.
The EBITDA margin takes EBITDA and divides it by a company’s total revenue. It is expressed as a percentage that shows how much money is retained from sales after operating expenses are subtracted, but before non-operating costs like taxes are accounted for. To calculate it, you first need to calculate EBITDA. Once you have your EBITDA figure, you can use the following formula to calculate the EBITDA margin:
EBITDA Margin = EBITDA / Total Revenue
What is a good EBITDA margin for your business?
A good EBITDA margin may fall between 15% and 25%, says Simon Thomas, Managing Director of accountancy firm Ridgefield Consulting. Generally, the higher the EBITDA margin, the greater the profitability and efficiency of a company.
Gold monitors the EBITDA margin at each of Popham’s London sites. He tells us that a good EBITDA margin for each site is 25% to 40%, depending on the type of operation. He also measures the EBITDA margin at a company-wide level. Here, he aims for an EBITDA margin of 15% to 25%. “The cost of sales and staff costs have the largest contributions to our EBITDA margin,” he says.
What is considered a ‘good’ EBITDA margin does vary depending on several factors, explains Thomas. This includes the industry your business operates in, the size and stage of growth of your company, your business model, the competition and any regulatory requirements you need to align to.
Some industries, like technology and software, can have higher average EBITDA margins, for example, due to lower overheads and higher scalability. Others, like manufacturing or retail, can have lower average EBITDA margins, due to larger overheads and bigger investments in equipment and property, such as machinery.
4 Ways to use the EBITDA margin in your business
1. Identify savings and efficiencies
Monitoring changes in EBITDA margin over time can help business owners identify where cost reductions and operational improvements can be made, explains Thomas.
A falling EBITDA margin, for instance, suggests your operating costs, such as raw materials and labour, are growing faster than your revenue. Using this data, you can implement changes, such as negotiating discounts with suppliers or improving productivity.
2. Scaling and growth
EBITDA margin is a valuable metric for understanding your company’s potential for growth. This is because a higher EBITDA margin indicates that a company can generate more profit relative to its revenue, leaving more resources available to invest in growth initiatives without sacrificing profitability.
“If our EBITDA strengthens, we open ourselves up to a conversation of growth and where best the company is ready for that,” shares Gold.
Tracking EBITDA margin as you scale, perhaps into new markets or as you launch new products, gives you visibility over whether your business is growing sustainably. If your EBITDA margin drops, for instance, it suggests your costs are escalating, and you’re making less money from sales.
By regularly evaluating your EBITDA margin, you can make cost reductions and efficiencies on an ongoing basis, so that your revenue grows without your costs growing proportionately.
Regularly calculating EBITDA margin also provides clear visibility over cash flow generation from core business operations. Understanding your cash position is vital as you scale, and the American Express® Business Gold Card comes with payment terms of up to 54 days to help give you greater flexibility in your cash flow¹.
3. Set financial goals
“Establishing EBITDA margin targets can provide a tangible benchmark for measuring business performance and driving strategic decision-making,” says Thomas.
By setting EBITDA margin targets, you can implement initiatives to help you reach them and then track your progress against these. For example, a business might introduce new software to boost employee productivity and sales output. Monitoring the EBITDA margin over time can indicate whether these changes improved earnings.
4. Compare performance
EBITDA margin is often used by business owners and potential investors to compare a company’s financial performance to industry peers or historical benchmarks, says Thomas. This is because it excludes expenses unrelated to operations or performance and therefore provides a clearer overview of financial health. Taxes, for example, change depending on location, or if new legislation is introduced.
Gold uses EBITDA margin to compare the performance of different sites at different times through the financial year. “Knowing how our EBITDA is affected seasonally, allows us to be prepared for the months to come around the following year.”
EBITDA margin vs other profit margins
EBITDA margin vs operating margin
EBITDA margin excludes amortisation and depreciation, whereas operating profit includes them. Amortisation and depreciation reflect the gradual loss in value of assets over time, such as equipment, property, trademarks and patents.
Both EBITDA margin and operating margin are expressed as a percentage of total revenue. However, because operating margin accounts for depreciation and amortisation costs, which can be significant in some industries, operating margin may provide a more detailed picture of overall profitability.
EBITDA margin vs gross profit margin
Gross profit margin subtracts the cost of goods sold (COGS) or the direct costs incurred from making your goods, such as raw materials, from your revenue. It divides this figure by total revenue to generate a percentage.
EBITDA margin goes further. It takes gross profit and deducts additional operating expenses that are not directly related to making your goods. These are often called ‘selling, general and administrative’ costs, or SG&A, on your income statement and include costs related to the day-to-day running of a company, like marketing, rent and utilities.
EBITDA margin vs net profit margin
Net profit margin is often referred to as the ‘bottom line’ because it subtracts all expenses from total revenue to show the portion of earnings that remain after everything has been accounted for. This means that - unlike EBITDA margin - net profit margin deducts interest, tax, depreciation, and amortisation expenses to provide a final view of a company’s profitability when all costs are accounted for.
“Tracking EBITDA margin fuels so much of our decision-making,” shares Gold. “We’re sometimes agile with our budgets, and good months of EBITDA can lead to increases in investments of sites and staff.”
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