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1、Different Types of Profit MarginsIntroductionUltimately, every business is trying to make money. There are various ways to measure a companys profitability, but the most basic is profit margin. Margin is an easy concept to understand: Its the percentage of a companys revenue that is left after expen
2、ses are paid, calculated by dividing profit (revenue minus expenses) by revenue. Bui there arc actually three types of margin that come in handy when analyzing a slock, each based on a different measure of profit and each useful in its own way.Types of MarginTo understand the differences between the
3、 three major types of margin, it helps to break down a companys expenses into three parts. First, there is the cost of goods sold, or cost of revenues. This represents (he expenses most directly involved in creating revenue, such as raw materials and labor costs for a manufacturer or the wholesale p
4、rice of goods for a retailer. Subtracting cost of goods sold from revenue gives gioss income, and dividing that figure by revenue gives gross margin. This number is close to most peoples intuitive notion of profit margin. For example, if it costs you S8 to make a widget and you sell it for $10, your
5、 gross margin is $2 divided by $ i 0, or 20%.But any business of a reasonable size will also have expenses that are less directly involved in creating revenue. These are called operating expenses and include costs for marketing, research and development, and administrative salaries-more peripheral e
6、xpenses that are nonetheless necessary for the companys everyday operations and that are particularly necessary for the company to grow. Subtracting both cost of goods sold and operating expenses from revenue gives you the companys operating income. Operating margin equals operating income divided b
7、y revenue. This figure provides a more accurate picture than gross margin of how profitable a companys overall day-to-day operations are. In our example, suppose you spend $i to advertise your widget; that cuts your 20% gross margin down to a 10% operating margin.Finally, there are expenses that are
8、 not related to the day-to-day operations of the company bul that have to be accounlcd for: costs such as interest expense, taxes, and some noncash charges such as write-offs. Subtracting these expenses from operating income results in net income, which in luni is used (o calculate net margin. This
9、is the margin figure youll find in most sources of stock inlbrmation, since ils the most accurate measure of how profitable a company is when everything is taken into account. If in the widget example, you have to pay $0.50 in tax on your $ 1.00 operating profit, you are left with a net margin of 5%
10、.How Margins InteractLooking at how these various margins relate to each other for a given company can be instructive. For example, consider Coca-Cola KO and PepsiCo PEP. In 1997, Cokes net margin was 21.9%, while Pepsis was less than half (hat-10.2%. Most of that difference arose from Cokes higher
11、gross margin of 68%, as opposed to Pepsis 59%. Those are both good figures for the beverage industry, but Cokes legendary brand name allows it more pricing flexibility, while its exclusive focus on producing symp-not bottling or making potato chips-keeps down the cost of goods sold. That translates
12、into a significantly higher gross margin, and that 9% advantage in gross margin is magnified when operating expenses and taxes (simikir for both companies) are taken out.On the other end of the scale, consider Cott COTTF, the Canadian company that makes discount private-label soft drinks for grocery
13、 stores. Cotts gross margin in 1997 was only 16%, a small fraction of Cokes and Pepsis. But Cotfs operating expenses were also much less, since it doesnt have a well-known brand to maintain and spends far less on sales and marketing than the two giants do. As a result, Cott posted a net margin of 2.
14、5% in 1997. But profits are more precarious for a company with low gross margins, and Colt lost money in both 1996 and 1998.Operating expenses are particularly important for retailers, whose gross margins are generally much lower than those of companies in other industries. Consider a couple of disc
15、ount retailers, Wai-Marl WMT and Kmart KM. Wal-Marts gross margin in 1997 was lower than Kmarts (20.4% versus 21.8%). because of its policy of keeping prices as low as possible. But Wal-Marts net margin was more than three times higher (2.9% versus 0.8%), because its operating expenses were signific
16、antly lower than Kmarts.Next, consider the leading Web retailer. A AMZN. Amazons gross margins have been about 20% every year; thats significantly lower than those of its main competitors. Borders BGP and Banies & Noble BKS, which both have gross margins of about 30%. On top of that. Amazons operating expenses (mostly marketing and sales) have been about 40% of revenues, giving the company a negative operating margin of 20% (that is, its operati
