EBITDA is Earnings before Interest, Tax, Depreciation and Amortization. As mentioned above, management can manipulate the bottom line by changing the depreciation rates. Also, manufacturing companies generally have higher depreciation figure compared to service companies. Financing decisions can alter the effective tax rate paid by a company. These factors make it hard to have a meaningful comparative analysis of a company with its competitors and other industry players. Hence, the EBITDA margin is a good measure for comparing companies across different industries. It is calculated as follows:
EBITDA Margin= EBITDA / Net Sales
EBITDA can be calculated by adding depreciation figures to the operating margin figure. This ratio is useful while comparing companies which carry large amount of fixed assets subject to heavy depreciation charges such as a mining company or an infrastructure company. It is also useful for comparing companies in a mature industries which are in a consolidation phase. Companies in consolidating industries tend to acquire significant tangible and intangible assets, such as a brands and copyrights, which are subject to large amortization charges.
As EBITDA measures the income which is available to pay interest charges, the EBITDA margin very importance to creditors and financial institutions. Companies with higher EBITDA margins are considered to be less financially risky than companies with low levels of EBITDA margins. In practice, the EBITDA margin is used only while analyzing large companies with significant depreciable assets, and for companies with a significant amount of debt financing.