EBITDA-to-Sales Ratio
Candlefocus EditorEBITDA 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.