MASTERCLASS – Company Health Ratios – Profit Margins

Company Health Ratios - Profit Margins

Company Health Ratios
Profit Margins

In the Profit & Loss Statement or Income Statement, there are four levels of profit or profit margins:

Gross profit (after cost of sales deducted from sales/revenue);

Operating profit (after expenses deducted);

Pretax profit (before tax and other non-regular items); and

Net profit (Final).

Note that “profit”, “earnings” and “income” are all used interchangeably, and mean the same thing.

When the term “margin” is stated, it can apply to the absolute number for a given profit level and/or the number as a percentage of net sales/revenues. Generally, margin is the amount of profit (at the gross, operating, pretax or net level) as a percent of the sales generated.

The absolute amount, the dollar amount, is on the Profit & Loss statement.

The profit margin uses the percentage calculation to provide a measure of a company’s profitability on a historical basis (3-5 years) and in comparison to peer companies and industry benchmarks.

So the:

Gross Profit margin is Gross Profit / Sales (GP divided by sales);

Operating Margin is Operating Profit / Sales (OP divided by sales), and so on.

The observation of profits over years can detect consistency or positive/negative trends in a company’s earnings. Positive profit margin analysis translates into positive investment quality. To a large degree, it is the quality, and growth, of a company’s earnings that drive its stock price, as well as earnings per share and Return on Equity.

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