The SpaceX Success Story
The world has seen many unconventional start-ups. However, almost all start-up companies derive their revenue from the earth. It is Elon Musk’s SpaceX that has opened up the investing community to a different dimension. Most of the businesses SpaceX is running and plans to run are related to outer space. Research related to outer space […]
Pros and Cons of Venture Debt
In the previous article, we have already studied about the concept of venture debt. We know that venture debt can prove to be a viable alternative for a start-up company that is looking to raise cash for a relatively short period of time. We also know how venture debt is different as compared to venture […]
Types of Hedge Funds
Hedge funds are simply funds with high leverage and no regulation. They have come into existence in the past couple of decades or so. However, a lot of fund managers have used different strategies and different asset classes. The result is a proliferation of the types of hedge funds. The modern investor therefore has a […]
Price to Earnings (PE) Ratio – Meaning, Formula and Interpretation
The price to earnings ratio is the most fundamental of all market related ratios. It has been used for decades by stalwarts in the investment community. However, it is also the ratio that has come under maximum fire from the skeptics. A variety of measurements have been developed to compensate for what skeptics call the […]
Lease Rental Discounting
Many corporations and individuals earn a significant portion of their income from rents that they derive from their immovable properties. The financing needs of these people are different from the vast majority of the population. It is for this reason that special products like lease rental discounting have been created to meet their needs. In […]
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.
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