profit margins

Examples of profit margins in the following topics:

• Profit Margin

  • Profit margin is one of the most used profitability ratios.
  • Profit margin refers to the amount of profit that a company earns through sales.
  • The higher the profit margin, the more profit a company earns on each sale.
  • The gross profit margin calculation uses gross profit and the net profit margin calculation uses net profit .
  • A low profit margin indicates a low margin of safety.

• The DuPont Equation

  • The DuPont equation is an expression which breaks return on equity down into three parts: profit margin, asset turnover, and leverage.
  • Profit Margin = 400,000/1,000,000 = 40%.
  • Profit margin is a measure of profitability.
  • Profit margin is calculated by finding the net profit as a percentage of the total revenue.
  • Companies with low profit margins tend to have high asset turnover, while those with high profit margins tend to have low asset turnover.

• Return on Total Assets

  • It is also a measure of how much the company relies on assets to generate profit.
  • The ROA is the product of two other common ratios - profit margin and asset turnover.
  • When profit margin and asset turnover are multiplied together, the denominator of profit margin and the numerator of asset turnover cancel each other out, returning us to the original ratio of net income to total assets.
  • Profit margin is net income divided by sales, measuring the percent of each dollar in sales that is profit for the company.
  • That can then be broken down into the product of profit margins and asset turnover.

• Operating Margin

  • The operating margin is a ratio that determines how much money a company is actually making in profit and equals operating income divided by revenue.
  • The operating margin (also called the operating profit margin or return on sales) is a ratio that shines a light on how much money a company is actually making in profit.
  • For example, an operating margin of 0.5 means that for every dollar the company takes in revenue, it earns $0.50 in profit.
  • A company that is not making any money will have an operating margin of 0: it is selling its products or services, but isn't earning any profit from those sales.
  • The operating margin is a useful tool for determining how profitable the operations of a company are, but not necessarily how profitable the company is as a whole.

• Uses of the Income Statement

  • Profit margin: A higher net profit as a proportion of sales indicates an overall higher capacity to capture returns on revenue.
  • Profit margin is one of the first aspects of an organization a prospective investor will look at when considering the overall validity of a company as an investment.
  • Operating Margin: Another useful indicator of profitability is operating income over net sales.
  • Comparing this to the overall profit margin can give useful indications of reliance on debt.
  • Another useful indicator is the gross margin.

• Ratio Analysis and EPS

  • Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.
  • Gross margin, Gross profit margin or Gross Profit Rate: Gross profit / Net sales
  • Profit margin, net margin or net profit margin: Net profit / Net sales
  • Ratio analysis includes profitability ratios, activity (efficiency) ratios, debt ratios, liquidity ratios and market (value) ratios

• Defining Operating Leverage

  • Utilizing operating leverage will allow variable costs to be reduced in favor of fixed costs; therefore, profits will increase more for a given increase in sales.
  • In other words, because variable costs are reduced, each sale will contribute a higher profit margin to the company.
  • The DOL tells us, as a percentage, that for a given level of sales and profit, a company with higher fixed costs has a higher contribution margin - the marginal profit per unit sold.
  • Therefore, its operating income increases more rapidly with sales than a company with lower fixed costs (and correspondingly lower contribution margin).

• Return on Common Equity

  • Return on equity (ROE) is a financial ratio that measures how good a company is at generating profit.
  • In essence, ROE measures how efficient the company is at generating profits from the funds invested in it.
  • ROE is the product of the net margin (profit margin), asset turnover, and financial leverage.
  • Also note that the product of net margin and asset turnover is return on assets, so ROE is ROA times financial leverage.
  • For example, if the net margin increases, every sale brings in more money, resulting in a higher overall ROE.

• Break-Even Analysis

  • Having high operating leverage (having a larger proportion of fixed costs compared to variable costs) can lead to much higher profits for a company.
  • To find the amount of units required to be sold in order to break even, we simply divide the total fixed costs by the unit contribution margin.
  • When sales have exceeded the break-even point, a larger contribution margin will mean greater increases in profits for a company.
  • Break-even analysis helps to provide a dynamic view of the relationships between sales, costs and profits.
  • Contribution margin (C) is the unit net revenue (P = price) minus unit variable cost (V = variable cost).

• Tax Deductions

  • A company's marginal tax rate is 35%.
  • However, to be deducted, the expenses must be incurred in furthering the business, such as it must contribute to profit.
  • Expenses incurred in order to generate profit for a company are referred to as business expenses.
  • Generally, this business must be regular, continuous, substantial, and entered into with an expectation of profit.
  • This graph plots the marginal income tax rates for the top tax bracket in the US from 1913 to 2009.