Operating margin and EBITDA are two measures of a company's profitability. They are related butprovide investors and analysts with different insights into the financial health of a company.
Operating margin, which is expressed as a percentage, is a measure of the revenue left over after accounting for expenses.It is the amount of profit that a company makes on every dollar once its costs of production are subtracted. It does not factor in the costs of taxes or interest payments.
EBITDA is an acronym for earnings before interest, taxes, depreciation, and amortization. It is reported as a dollar figure. It indicates a company's earnings before factoring in non-operating expenses.
Key Takeaways
- A company's profitability can be measured in several ways, including common calculations such as operating margin and EBITDA.
- Operating margin gives you the ratio of income to expenses. Higher margins indicate higher degrees of profitability.
- EBITDA, or earnings before interest, taxes, depreciation, and amortization, lets you see how much money a company earns before accounting for non-operating expenses.
Operating Margin
Operating profit margin is aprofitability ratiothat investors and analysts use toevaluatea company's ability to turn revenue into profit after accounting for expenses. It's the percentage of revenue that is left over after paying expenses.
Two components go into calculating operating profit margin:revenue and operating profit. Revenueis listed on the top line ofa public company's income statement and representsthe totalincome generated fromthe sale of goods or services.Revenue is sometimes referred to as net sales.
Operating profit is the amount of revenue that remains afterall ofthe day-to-day operating expenses have been subtracted. However, some costs are not included such as interest on debt, taxes paid, profit or loss from investments, and any extraordinary gains or losses that occurred outside of the company's daily operations such as the sale of an asset.
The day-to-day expenses included in figuring the operating profit margin include wages and benefits for employees and independent contractors, administrative costs, the cost of parts or materials required to produce items acompany sells, advertising costs, depreciation, and amortization.
In short, any expense that is necessary to keep a business running is included, such as rent, utilities, payroll,employee benefits, and insurance premiums.
While operating profit is the dollaramount of profit generated for a period, operatingprofit margin is the percentage of revenue a company earns after taking out operating expenses.The formula is as follows:
OperatingProfitMargin=RevenueOperatingIncome×100
Examining the operating margin helps companies analyze, and hopefully reduce, variable costs involved in conducting their business.
EBITDA
EBITDAorearningsbeforeinterest,taxes,depreciation, andamortization is reported as a slightly different take on a company's profitability.
EBITDA strips out the cost of interest on debt and taxes. It also removesdepreciationandamortization, which are non-cash expenses, from earnings.
Depreciation is an accounting method of allocating the cost of a fixedasset over its useful life rather than all at once when it is purchased. It is used to account for an asset's decline in value over time. In other words, depreciationallows a company to expenselong-term asset purchases over many years, during which time it is generating profitfrom deployingthe asset.
Depreciation and amortization expense aresubtracted from revenue when calculating operating income.Operating income is also referred to as a company's earnings before interest and taxes (EBIT).
EBITDA, on the other hand, adds depreciation and amortization back into operating income as shownby the formula below:
EBITDA=OI+D+Awhere:OI=OperatingincomeD=DepreciationA=Amortization
What Does EBITDA Tell You?
Some investors and analysts see EBITDA as giving a more accurate picture of a company's real performance. It clears away factors like depreciation that can cloud the picture. What remains can more clearly show a company's real financial performance.
EBITDA is often used to analyze and compare profitability among companies in the same industry.
For example, a capital-intensivecompanywith a large numberof fixed assets would have a lower operating profit due tothe depreciation expense of the assets when compared to a company with fewer fixed assets. EBITDA takes out depreciation so that the two companies can be compared without any accounting measures affecting the numbers.
The Bottom Line
Operating profit margin and EBITDA both measure a company's profitability.
Operating margin measures a company's profit after paying variable costs but before paying interest or tax, then divides it by revenue to arrive at a percentage that indicates the company's success at turning a profit.
EBITDA measures a company's overall profitability in dollars but may not take into account the cost of capital investments like property and equipment.
The main difference between the two metrics is the elimination of depreciation and amortization. Neither of these items is cash on either side of the ledger.
EBITDA is a cash-focused metric for stakeholders who care about the cash flow of the business. Operating profit is an accounting metric for the stakeholders who care about the operational profitability of the company.
