Municipal Bonds
We already know that bonds are issued by a wide variety of entities. Bonds are routinely issued by corporations, banks, and even governments all over the world. A special category of bonds called municipal bonds (munis) are issued by various local governments across the globe. These bonds are often categorized separately because they have certain […]
Personal Financial Statements
It is common practice for businesses to prepare financial statements. This is because they need to get these financial statements audited. Once these statements are audited and found to be correct, they become an official record that can be used in loan applications as well as for tax purposes. However, since individuals do not need […]
Qualitative Issues While Conducting Equity Valuation
Equity valuation focuses on estimating what the likelihood of the company being a successful enterprise in the future is. Now, it is difficult to construct any model which can predict the success of any enterprise. For example, consider the fact that new age companies like Google and Facebook share almost none of the characteristics that […]
How Reverse Pitching Works? – Its Advantages & Disadvantages
Start-ups connect with large corporations in many ways. The most common way for start-ups to connect with their larger counterparts is when they try to raise funds from these companies. It is common for start-up companies to approach bigger firms in order to pitch their business. However, a lot has changed in the start-up community […]
Why Should Central Banks Be Independent?
Last month Donald Trump fueled a debate when he called the Fed “crazy.” Political accusations started flying all across the media. However, it raised a very important point. The world realized that Donald Trump is not in control of the Federal Reserve which is the central bank of the United States. To the financially savvy, […]
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 *
