EBITDA margin (Earnings before interest, taxes, depreciation and motivation) = (Total revenue- Cost of revenue- Administrative expenses)/ Total revenue EBITDA ratio helps us deduce the relationship between a company’s net sales and operating profit. It is a perfect financial metric to determine a company’s profitability because it does not recognise the effect of interest on debts, taxes, depreciation and amortisation while calculating the operating profit.
Interpretation of EBITDA
The ratio of EBITDA indicates how much cash a company can generate on each rupee of revenue without taking into account external and non-operational costs. It also helps us to analyse the ability of the company to pay off its future financing. One can also analyze the performance of a company by comparing its EBITDA against its competitor’s ratio, industrial average and macroeconomic trends. Many startups use this ratio because they need heavy upfront investment to scale and function effectively. If a company has a high EBITDA percentage, it means the company has low operational costs and disciplined and efficient cash flows.
Limitation of EBITDA
Since EBITDA margin excludes interest expenses, it becomes difficult to assess the financial health of companies that relies heavily on debts. Also, EBITDA is a non-GAAP metric which means a company can compute its EBITDA ratio at its own discretion without considering the GAAP guidelines. Many companies exploit this loophole to present a false positive image of their financial health in order to lure investors.