EBITDA Margin vs Operating Margin
Hello guys,
I´m currently working on a model and have a few questions, just to check back if my thinking process is right. I have a company where the operating margin is relatively stable at around 20% with around ~0,50% growth every year, some years stagnating though.
On the other hand I see the EBITDA margin rising higher then the OP margin. The only difference (correct me please if I´m wrong) between EBITDA margin and operating margin is D/A.
So the conclusion is that the firm has been more efficient with D/A or it simply meant that some assets/machines where fully depreciated or sold and therefore the D/A "expenses" were lower = higher EBITDA margin. (?)
Would be very happy to hear your input, I´m still very new to financial modeling but I try to get better everyday.
edit: One last thing, I do see the D&A expenses only on the CFS statement and not seperated on the income statement. When I calculate D&A back to operating profit I get close to EBITDA but I also have to add back (other income) expenses that I get to the correct number. Can someone explain me what that other income expenses are, they come after interest on the income statement.
Thank you
Chris!
If a company's operating margin is flat, that means the company's expenses (variable and fixed) are growing at the same delta as revenue. If there is margin expansion, then the implication is that the company has operating leverage, i.e. fixed costs such as rent, supplies, administration costs do not increase (or increase at the same rate of change) as revenue growth. Typically operating income is synonymous with EBIT.
As for your question, the first thing to confirm is that the reported EBITDA you are analyzing is not "adjusted EBITDA", where the company might add back stock-based compensation, one-time costs(if the company buries them in operating expenses), and other items that should be normalized. If it's just regular EBITDA, you are correct in your assumption of the formula being EBIT/operating income + D&A expense.
If you are seeing margin expansion in EBITDA (not adjusted EBITDA) but a flat EBIT margin, it means that D&A expense is increasing year over year, which would arise from a change in depreciation methods or high CapEx in previous years, which would warrant a greater D&A expense. The reason why EBITDA margins increase with higher D&A expense is because typically D&A is buried in operating income, but is stripped out for the EBITDA calculation. An example below:
Year 1 revenue: 1000 Year 1 operating income: 200 (20% margin) Year 1 D&A: 50 Year 1 EBITDA: 250 (25% margin)
Year 2 revenue: $1500 Year 2 operating income: 300 (20% margin) Year 2 D&A: 125 Year 2 EBITDA: 425 (28.3% margin)
In the above scenario, the EBIT margin remained flat across year 1 and year 2, while EBITDA increased purely as a result of higher D&A expense recognized in the period. It's hard for firms to be "efficient/inefficient" with D&A because its something outside of your control (aside from the method of depreciation the company chooses to use vs tax D&A).
Regarding your last question, companies have different definitions of other income (expenses). Typically you have to look at the notes in the 10K to figure out what it relates to. However if the company is adding it back to calculate EBITDA, its likely because its recurring every year(but not core to the company's operations). Hope this helps.
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