What are Capitalization Tables?
The capitalization table is a very important record for any startup company. These tables provide a clear and unambiguous report of who owns and controls what percentage of the startup’s shares. It is considered to be the final and irrefutable record that provides details about the ownership of the company. Since decisions involving financing, sale, […]
Degree of Operating Leverage Ratio
The degree of operating leverage of a company is very important from an investor’s standpoint. Although it shows the riskiness of a venture, it also shows the efficiency of a company. Just like, financial leverage arises out of the capital structure of a company, operating leverage arises out of its cost structure. If a company […]
Money Market Futures – Meaning and Types
The money market is a full-fledged financial market. Hence, there are many investors who are keen to hedge the risks which emanate from the money market. The need to hedge these risks has led to the creation of several money market derivatives. There are certain exchange-traded derivatives that are a part of the money market […]
Capital Budgeting and Depreciation
Depreciation is an important concept in capital budgeting. This is because it is a non cash expense and ideally should not have any effect on the cash flows. This is the reason why it is added back during cash flow calculations. Since the amount of depreciation never actually left our bank account in the form […]
Herd Mentality Bias
Human beings are social animals. For centuries, our brains have been wired to conform to the actions of the larger group. This is because, in the old times, a person’s probability of survival would be negatively impacted if they were not in a group. This herding mentality may have helped our forefathers survive in the […]
The untrained investor uses profit and profit margin interchangeably. This is not technically correct. The difference may be minor but it is vital. This article will explain about profit margins in detail.
Profit and profitability are two different things. Although they may be closely related, they have a subtle difference. Profit is the absolute number that a company is earning. Profitability on the other hand implies profit margins. Margins are calculated on a per unit basis. Secondly they consider the amount of capital that has been employed to generate the profit. Thus profitability i.e. profit margins are a wider concept.
There are different measures of profitability that a company can choose from. Similarly there are different profit margins that a company can choose from. It is common practice to convert each profit figure into a margin.
Margins need to be compared with industry and relevant competition. A 15% return may be great for a utility company but may suggest serious problems with an information technology firm. Luxury brands such as Armani, Rolls Royce, and Rolex have very high profit margins. This is because the cost that they put in is small and they are reaping the benefits of the brand that they have created. Comparing a Rolls Royce profit margin to a Maruti would not be advisable even though both of them are cars.
Profit margins are very important to understand how diminishing returns work in the context of the firm. Using various profit margins, the firm can look at the profitability figures and find out the level of production where the costs are minimum and profit margins are high. This is the quantity that the company should optimally produce.
The drawback with profit margins is that they do not consider volume. It is for this reason that a separate Cost-Volume-Profit analysis often needs to be done. Usually profit margins and volume are inversely proportional to each other. Higher margins indicate lower volumes and vice versa. There are unusual cases where margins and volumes are both high. However, these are usually examples of monopoly.
Your email address will not be published. Required fields are marked *
