Intermediate3 min readFundamental Analysis and Financial Statements · 10/15
Profit Margins: Gross, Operating and Net
Profit in pounds grows as a company grows, so on its own it does not tell you whether the company became more efficient. A margin turns profit into a share of sales, so years can be compared fairly.
What you will learn
Compute gross, operating and net margins.
See how profit can rise while the margin shrinks.
Know why comparisons belong within the same sector.
The lesson as a short video · 20 seconds · Watch on YouTubeIn this lesson
Gross marginGross profit ÷ revenue. The share of each sale left after direct costs.
Operating marginOperating profit ÷ revenue. Measures the whole business before interest and tax.
Net marginNet profit ÷ revenue. What shareholders keep from each pound of sales.
The invented company Al Wadi Foods sold 1,000 million, with gross profit of 400, operating profit of 150 and net profit of 93. Margins: 400 ÷ 1,000 = 40%, 150 ÷ 1,000 = 15% and 93 ÷ 1,000 = 9.3%.
Profit up, margin down
ExampleLast year revenue was 800 million, gross profit 336, operating profit 128 and net profit 80. Every profit figure rose this year, yet every margin dipped a little. The company grew, but each pound of sales left less profit. Perhaps materials got dearer and prices could not rise as much, or it cut prices to sell more. The statements and notes will tell you.
Last year
This year
Revenue (m)
800
1,000
Gross margin
42%
40%
Operating margin
16%
15%
Net margin
10%
9.3%
Sales rose 25% while all three margins slipped.
What each margin points to
If the gross margin fell, start with selling prices and material costs. If gross held and operating fell, admin and marketing costs grew faster than sales. If operating held and net fell, look at interest, tax and one-off items.
Watch outDo not compare margins across sectors. A supermarket sells a lot at a thin margin; a software company may have a far wider one. A high margin is not better in itself; compare companies doing the same work, or the same company over several years.