EBITDA understanding margin formula with examples

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Marketopedia / Fundamental Analysis / EBITDA understanding margin formula with examples

Under the Profitability Ratio, we need to look into some figures. These include the return on assets and the return on equity.

  1. EBITDA Margin (Operating Profit Margin)
    • EBITDA Growth (CAGR)
  2. PAT Margin
    • PAT Growth (CAGR)
  3. Return on Equity (ROE)
  4. Return on Asset (ROA)
  5. Return on Capital Employed (ROCE)

EBITDA Margin:

The Earnings before Interest Tax Depreciation & Amortisation, which is also known as EBITDA margin, is an indicator of management efficiency. It shows the profitability (in percentage terms) of the company’s operations, and it can be a helpful comparison tool when looking at its competitors. This makes it easy to assess how well the company’s expenses are managed.

To determine the EBITDA Margin, we must first compute the EBITDA.

EBITDA can be calculated by subtracting operating expenses from operating revenues. 

Operating revenues, on the other hand, are derived from the total revenue minus other income. 

Similarly, operating expenses are determined by subtracting finance costs and depreciation & amortisation from the total expenses. 

The EBIDTA margin is obtained by dividing EBITDA by the difference between total revenue and other income.

To illustrate, for Amara Raja Batteries Limited, the EBITDA margin in FY14 was computed as follows:

We start by computing EBITDA, following this formula:

[Total Revenue – Other Income] – [Total Expense – Finance Cost – Depreciation & Amortization]

Overall, Other Income can’t be considered when computing EBITDA since it would distort the data. Therefore, it must be excluded from Total Revenues.

[3482 – 46] – [2942 – 0.7 – 65]

= [3436] – [2876]

= 560 Crores

As a result, the EBITDA Margin can be calculated.

560 / 3436

= 16.3%

At this juncture, I need to ask you two questions.

  1. What does an EBITDA of Rs.560 Crs and an EBITDA margin of 16.3% signify?
  2. How good or bad an EBITDA margin of 16.3% is?

The first question is relatively uncomplicated. An EBITDA of Rs. 560 Crs implies that the company kept Rs. 560 Crs from its total revenue of Rs. 3436 Crs. This infers that out of the Rs. 3436 Crs, the firm dedicated 83.7% towards expenses and held onto 16.3% for their tasks at the operating level.

We will now understand the answer to the second question. 

We have already discussed in this chapter that a 16.3% EBITDA margin, by itself, does not tell us much. To gain some insight, it is necessary to visualise the trend or else compare it with similar businesses.

To gain insight into ARBL’s EBITDA margin, let us inspect its trend over the last four years (all figures in Rs Crs, excluding EBITDA margin).

ARBL has kept their EBITDA at an average of 15%, and on closer inspection, its margin seems to be growing. This reflects stability and proficiency in the management’s operations, which is very positive.

In 2011, the EBITDA was a respectable Rs.257 Crs, and by 2014 it had grown to Rs.560Crs, representing an impressive 21% CAGR across the 4 years.

Please be aware that we have reviewed the formula for CAGR in module 1.

It is evident that ARBL’s EBITDA margin and growth are impressive. Nonetheless, to see if it is the finest, a comparison with its competitor -Exide Batteries Limited- must be done. You should scrutinise Exide’s results as well to make a decision.

PAT Margin:

The EBITDA margin is worked out at the operating level, considering just operating expenses; factors like depreciation and finance costs are not included. Whereas to identify the overall profitability of a business, the Profit After Tax (PAT) margin is calculated by subtracting all expenses from Total Revenues. This includes tax expenses as well.

PAT Margin = [PAT/Total Revenues]

The Annual Report clearly has our PAT at Rs.367 Crs, based on total revenue of Rs.3482 Crs, including other income. This gives us a PAT margin of:

= 367 / 3482

=10.5 %

The performance of ARBL on a PAT level and the PAT margins are presented here. The figures demonstrate a steady improvement over the past few months.

The PAT and PAT margin path appears favourable, with a 4-year CAGR growth rate of 25.48%. Comparing the figures to its competitors’ is always advisable.