CandleFocus

EBITDA-to-Sales Ratio

The EBITDA-to-sales ratio (EBITDA margin) is an important financial metric that measures how much cash a company generates for each dollar of sales revenue. The result is an indicator of a company’s profitability and cash flow health that excludes the impact of interest, taxes, and amortization & depreciation. The formula for calculating this ratio is EBITDA divided by sales. It is also commonly referred to as EBITDA margin or EBITDA return on sales.

EBITDA stands for earnings before interest, taxes, depreciation, and amortization and is a measure of a company's core operating performance without the impact of one-time costs and other non-cash expenses such as amortization & depreciation. This metric is especially useful when using a company’s financials to compare it to its peers in the industry since it excludes the impact of the company’s individual capital and depreciation structure. For example, a company may choose to depreciate its assets differently than its peers, causing variances that could affect the comparison and distort the true evaluation of performance.

The higher the EBITDA-to-sales ratio, the more profitable the company is considered to be and that its cash flow is stable. A higher EBITDA-to-sales ratio indicates that the company is able to generate more cash from sales. A low EBITDA-to-sales ratio, however, suggests that the company may have problems with profitability, cash flow, or both. A low ratio may indicate that the company is operating inefficiently, has too-heavy debt service payments, or both.

It is important to remember that the EBITDA-to-sales ratio does not account for debt levels. Therefore, it should not be used for companies that have a high debt-to-equity ratio. Highly leveraged companies, in particular, often have large interest payments that can significantly reduce their profits and thus should not be evaluated using this metric.

The EBITDA-to-sales ratio provides investors with a more accurate picture of a company’s performance, as it excludes non-cash expenses such as amortization & depreciation, allowing for an apples-to-apples comparison of companies in the same industry. While the results should not be taken at face value, it can be a useful metric for investors who are looking for a quick way to compare companies and determine which ones may offer a stronger financial return.

Glossary Index