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EBITDA Margin and Adjusted EBITDA Margin are similar measurements used by business owners and others who value businesses for sale. Let’s break down the two terms to help your understand which measurement of profit and cash flow are most relevant for your business.
EBITDA Margin or Earnings Before Interest, Taxes, Depreciation, and Amortization Margin is a measurement of a company’s “top line” operating profitability expressed as a percentage of its total revenue.
EBITDA Margin therefore provides outside investors, business owners, and potential buyers with a clear view of the business’s operating profitability and cash flow, since the valuation excludes interest, taxes, depreciation, and amortization.
Adjusted EBITDA Margin vs. EBITDA Margin
Adjusted EBITDA Margin differs from EBITDA Margin in that adjusted EBITDA Margin normalizes income and expenses, given the fact that not all companies treat income and expenses the same.
Because Adjusted EBITDA Margin standardizes cash flows and removes anomalies, it is a useful tool to compare multiple companies in an “apples-to-apples” fashion.
Adjusted EBITDA Margin is commonly used as a measurement of cash flow for mid-sized businesses because often owners of these businesses commingle personal expenses with business expenses and sometimes over or under compensate those associated with the business.
Adjusted EBITDA Margin Formula
Adjusted EBITDA Margin is calculated as follows:
Add or Subtract: anomalies such as below or above market rents paid to related parties, below or above market compensation paid to employees, one-time expenses or revenue;
Add: personal expenses deducted by the business paid on behalf of its owners;
Subtract: Interest Expense, Income Taxes, Depreciation, and Amortization.
Divided by Gross Revenue
Benefits of Adjusted EBITDA Margin
Adjusted EBITDA Margin, by definition, allows a direct comparison of multiple companies – regardless of size, location, or industry. It breaks down operating profit as a percentage of revenue, allowing other business owners or investors to understand how much operating cash is generated for each dollar of revenue earned.
Drawbacks of Adjusted EBITDA Margin
Because EBITDA excludes debt, there are some drawbacks to using adjusted EBITDA Margin to measure the performance of a company. Some companies may use EBITDA Margin deceptively to enhance the perception of their financial performance, especially if the company has a large amount of debt.
Additionally, EBITDA Margin is usually higher than profit margin, and companies that have low profitability may use EBITDA Margin as a way to present a deceivingly high level of financial success.
Lastly, EBITDA Margin as an accounting measure is not regulated by GAAP, making it possible for companies to skew numbers in their favor.