Profitability Ratios And Margins
There are two main profitability ratios namely gross and net margin ratios that I mentioned in my analyses.
Gross Profit Margin
Gross Profit = Revenue – Cost Of Goods
This margin reveals the ability of the business in pricing above its cost of producing or sourcing the goods being sold. The gross profit margin, for companies that produce their own products, also reveals the efficiency in keeping the costs of products lower. The efficiency could be due to a wide variety of reasons such as more advanced technology, superior logistics and cheaply sourced raw materials.
Net Profit Margin
Net Profit = Gross Profit – Expenses + Other income – Tax
This margin shows how much profit the company is able to make per dollar of revenue after deducting all the necessary business expenses incurred by the business’s operations during the financial year ended. However, a word of caution regarding the use of net profit due to the influence of tax rates which can be manipulated. Hence, if in doubt, use pre-tax earnings margin over time for comparison and analysis.