Understanding the profitability of a business is very important when you are looking to invest, lend, or make other business decisions. There are many important metrics that you should look at when you are assessing the strength and viability of a business. One of the most important continues to be the EBITDA margin, which ultimately shows the profitability percentage relative to the revenue of a company. There are various pieces of information that you will need to determine the EBITDA margin of an organization.
One of the first steps that you will need to take is to calculate the EBITDA of a business. To calculate the EBITDA, you will only need the income statement for the company. EBITDA is a very popular and common metric used for business analysis as it ultimately shows the income of a business after adding back non-operating costs, taxes, and debt-service payments. EBITDA stands for Earnings Before Interest Taxes Depreciation and Amortization.
To calculate the EBITDA of a business, you will need to start with the net income in a certain financial period. Once you have found the net income, which should be at the bottom of the income statement, you will need to add back interest payments, tax payments, amortization costs, and depreciation expenses. The resulting figure will then be the EBITDA of the organization.
While calculating EBITDA is relatively straightforward, it is common for businesses and financial institutions to make adjustments to the EBITDA number based on factors of the business. Ultimately, stakeholders will want to be able to get a good sense of the recurring income and excluding non-recurring costs and revenue can make sense. Some common costs and sources of revenue that could be used to adjust EBTIDA will include non-recurring expenses such as one-time legal or acquisition costs, key employee compensation that is no longer being paid out, or changes to rental expenses based on new lease agreements. It also is common to adjust your revenue if you have incurred non-recurring sources of income during the period of time being evaluated.
Calculate EBITDA Margin
Once you have calculated the appropriate EBITDA, you will need to know the EBITDA margin formula. This is a rather simple formula that will take your EBITDA during a period of time and then divide by revenue earned during the same period. You can have this compiled for both the adjusted and unadjusted EBITDA. If there are non-recurring sources of revenue, you should adjust for this calculation as well. As an example, if revenue during a period of time was $1 million and EBITDA was $150,000, the EBITDA margin would be 15%.
How to Use EBITDA Margin
EBITDA margin is an important metric that is used when evaluating a business. Generally, the higher the EBITDA margin is, the more profitable the business can be. However, companies in growth mode that have a lot of operating expenses could still be operating with a negative margin. Due to this, it is important to evaluate the trends of margins. If the margin is declining, it could be a sign that costs are increasing and they are not able to recoup this additional expense through higher revenue. On the other hand, if the margin is flat or increasing, it could be a positive sign. It would also be a good idea to compare margins to competitors in the industry to see how the company stacks up to the competition.
When you are assessing a business, understanding profitability and margins is very important. One of the most important metrics to understand is the EBITDA margin, which ultimately shows how much profitability a company has compared to its revenue. By following this EBITDA margin formula, you can calculate this profitability margin for any given period of time.
Krishna Murthy is the senior publisher at Trickyfinance. Krishna Murthy was one of the brilliant students during his college days. He completed his education in MBA (Master of Business Administration), and he is currently managing the all workload for sharing the best banking information over the internet. The main purpose of starting Tricky Finance is to provide all the precious information related to businesses and the banks to his readers.