EBITDA Margin vs Operating Margin: What’s the Difference?

One attempts to analyse a particular company to make the best out of the investments. Even when one is not in the greatest league as an expert and a professional analyzer, it is possible to conduct primary research. You can certainly help yourself determine the profitable avenues of investment and identify stocks or other assets, providing you the best opportunities to make the earnings you desire. 

Many indicators can assist you in spotting the revenue-generating potential of stocks of various companies. The best known of the two such indicators popular for their precise results are the EBITDA margin and the operating margin. Therefore, an investor must mark the difference between operating margin and EBITDA margin. 

Both indicators form an essential part of the companies’ fundamental analysis and technical analysis. At the same time, EBITDA points out a company’s earnings before the interests, taxes, depreciation & amortization. Likewise, the operating margin gives a picture of operating costs. Always very helpful in analyzing companies, both the indicators present a clear case for the investors. It is, thus, necessary not just to understand their work. 

At the same time, see operating margin vs ebitda margin. The EBITDA is a popular measure to assess the operational success of a business entity. To measure the profitability thus, the investors choose the EBITDA margin. The operating margin is also a key measure of profitability that shows the relation between the total sales and the profits generated in the period.

How are Operating Margin And EBITDA Different?

Although the two indicators give an idea regarding profitability, there are some stark differences that we must note. Some of the significant ones include the following.

1. The EBITDA determines the total earnings possible for the company but the operating margin. On the other hand, it shows the amount of profit the company can make from its current operations. 

2. In EBITDA, there is scope for adjustments in amortization and depreciation. It is not the case with operating margin where one has to stick to the exact details.

3. The EBITDA does not lie in the Generally Accepted Accounting Principles (GAAP). So this measure is not usable for financial reporting. However, the operating margin officially comes under the GAAP. So the companies used to announce the EBITDA in a particular year if the results were well and good. If the results don’t signal profits, they choose not to disclose the results. Investors should trust the companies that bring their EBITDA into the light consistently. You can easily find out about the company’s performance with EBITDA and other valuable data.

EBITDA  and operating margin both have their share of benefits and limitations. You should thus employ both methods to conduct the research into a company’s performance.

Understanding the Operating Margin

The operating margin, an important metric to gauge the profitability of a business entity, shows the profits generated in proportion to the outstanding sales in the given time. It is also famous for the name operating ratio; it is usually used for operating profits. However, this is not the correct way of using the ratio. The operating margin functions in terms of percentage and stands for the profits generated in proportion to sales of Re. 1.  For example, if the company’s operating margin is 17%, it shows that the company has Rs. 0.17 as the profits as against the Re. 1 of revenue generated.

Here we take away all the operational costs. These include the ones that are either directly related to the business operation or indirectly assisting in the business activities. Hence it brings out the share of the revenue a company could use for the non-operational expenditure. It may include easing the liabilities, spending on achieving growth, paying the dividends, or keeping it as strategic reserves. 

Calculation of Operating Margin

To calculate the operating margin, we first need to determine the operating profits. For this, the formula used is as follows.

operating profit = net sales – (COGS + Administrative overheads + Depreciation and Amortisation)

As gross profit is COGS deducted from the net sales, one can also represent it in the following way too:

operating profit = Gross profit – (COGS + Administrative overheads + Depreciation and Amortisation)

The costs like the labor charge, raw materials, freight charges, and packaging constitute the total expenditure on the production of goods by the company. Administrative overheads include the expenditure made during the day-to-day operation of the company. They comprise the salary, finance, office rent, warehouse costs, etc.

As we have the operating profits, we need to divide the result obtained by the total revenue. so the formula becomes, 

operating margin = operating profit / net sales.
other terms, operating margin = ( net sales – operating costs) / net sales.

Despite being a reliable method to trace an organization’s profits, some experts use it to analyze the risks involved in the organization.

What is the EBITDA Margin?

EBITDA  stands for the earnings before interest, tax, depreciation, plus amortization. It is a widely used indicator to trace the financial health of an organization. Yet it is only successful in revealing the profits and not the company’s profitability. So the EBITDA margin comes into play here. It is the ratio of the company’s net sales to the operating profit post the deduction of depreciation and amortization. It consists of two types- EBIT and EBITA.  The efficiency of this measure in detailing a company’s profitability is higher than EBITDA, which is a non-GAAP method.   

Calculation of EBITDA Margin

As the calculation of EBITDA  margin involves net sales, the two kinds of expenses are necessary. These are the manufacturing overhead, the costs incurred for the said revenue generated, and the administrative overhead. As discussed earlier, manufacturing overheads include freight, raw materials, labor, and other variable costs. The administrative overheads include salaries, electricity bills, office rent, and other costs that do not directly contribute to production or revenue generation.  

We would first require the EBITDA and the formula for the same is as follows.

EBITDA = cost of revenue – administrative expenditures.

Further to find the EBITDA margin, there is the following formula. 

EBITDA margin= Total revenue – (Cost of revenue + Administrative expenditures) / Total revenue. In simpler terms EBITDA margin = EBITDA / Total revenue.

Conclusion

The operating margin and EBITDA margin both are significant metrics to measure the profitability of business entities. The operating margin considers a company’s profit by subtracting the variable costs before interest and tax payments. The EBITDA, in contrast to this, gives the profitability of an organization on the whole. It does not involve the capital investment expenses, though, like the costs of property or equipment. 

The two indicators are productive enough to bring out a comparison between multiple companies. Still, they have specific inherent differences. Therefore, it is essential to know how is operating margin And EBITDA different? A better understanding of this only can help us use the two indicators to their highest potential.

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