Your business operation’s EBITDA (earnings before interest, taxes, depreciation, and amortization) is often a useful shorthand measure of your company’s profitability.
EBITDA can have its drawbacks as a metric, since it doesn’t account for capital investments or the impact of debt interest on the bottom line, but it can be a useful way to estimate cash flow, which is an essential measure of business health.
EBITDA is an important measure in the business valuation process. Business valuations are often presented and expressed as multiples of EBITDA, across many industries.
But what about EBITDA margin? What is EBITDA margin, how is it calculated, and what can it tell a buyer or seller about a business?
Maybe most important, is EBITDA margin a relevant measure for business owners to be thinking about when considering a company sale?
What is EBITDA Margin?
If your EBITDA is a measure of your business’s operating profit or cash flow, then your EBITDA margin is that cash flow expressed as a percentage of the company’s annual revenue.
The EBITDA Margin Formula
The formula for calculating EBITDA margin is simple:
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EBITDA ÷ revenue = EBITDA margin |
What is EBITDA Margin Useful For?
In short, EBITDA margin can be useful for comparisons of two or more companies’ relative profitability, but certain factors can limit EBITDA margin’s usefulness.
Let’s say you’re examining several companies of varying sizes within the same industry — some have significantly more customers, bring in a lot more in revenue, and have more employees, etc. Others are much smaller.
By calculating EBITDA margin for each business and comparing the percentages, you create a closer, more accurate comparison of those companies’ profitability. A higher EBITDA margin indicates higher profitability.
A comparison of EBITDA margins can help show you which companies are doing a better job minimizing waste, cutting costs, and optimizing efficiencies. Larger companies may have much higher revenue, but a comparison of EBITDA margins can reveal weaknesses or synergies at scale.
ALSO READ: How and Why to Calculate and Compare EBITDA to Free Cash Flow
Potential buyers may compare EBITDA margins if faced with multiple options, to help determine which acquisition may have greater profitability potential.
In the same way, business leaders can use year-over-year comparisons of annual EBITDA margin reporting to evaluate performance improvements, and determine whether cost-cutting, waste reduction initiatives, and other improvements have their intended impact on the company bottom line.
Shortcomings of EBITDA Margin
Because EBITDA doesn’t include debt costs, EBITDA margin can be misleading when it comes to companies that carry high debt burdens and pay a lot in interest. By failing to account for the costs associated with debt and a business’s working capital requirements, EBITDA margin simply doesn’t present a complete picture about enterprise value.
That’s why it’s important to note that, for all its potential value to a business leader making improvements or assessing options for acquisition, EBITDA margin isn't an essential measure used for calculating a valuation determination for an employee stock ownership plan transaction.
You Should Still Care About EBITDA Margin
EBITDA is an important part of valuation, especially when it comes to valuation for an employee stock ownership plan (ESOP). That’s because EBITDA is a reliable indicator of a company’s cash flow.
An ESOP company’s tax benefits can have a significant, positive impact on cash flow. When you work with an ESOP expert to explore feasibility for your company, you’ll take a close look at tax liabilities as well as cash flow. EBITDA also factors into the evaluation, as it is useful in valuation analysis.
So, does EBITDA margin matter?
As a measure of profitability and efficiency, and as a means for monitoring the impact of continuous improvement initiatives, EBITDA margin does matter — and ultimately, those business improvements can have a positive impact on the value of a company.
If you’re an owner of a closely held company, and you’re starting to consider your horizon, exit strategies, and succession planning options, optimizing your EBITDA margin can certainly help you make sure your business is in the best possible condition for sale.
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Selling a closely held company to an ESOP can give a business owner flexibility and control over the transition that other sale options can’t, while also providing a unique employee retirement benefit — and leaving behind a legacy of community-supporting employment.
Could an ESOP sale be the best option for selling your business?
The best way to find out if your business is a good candidate for an ESOP, and if an ESOP is right for you, is by scheduling a free, no-obligation ESOP Feasibility Analysis.
At no cost to you, our ESOP experts will help you understand exactly how an ESOP works, and review your business and your objectives to explore whether selling to an ESOP could be a good fit. Just click the link below to request your free ESOP Feasibility Analysis.