Profit Margin
Would you like to invest your money? Get in touch with an expert:
What is Profit Margin?
The profit margin is a widely used measure of profitability. It indicates the percentage of a company's revenue that represents profit. Essentially, the profit margin serves as a key indicator of a company's financial health, growth potential, and the efficiency of its management.
In general, a company's profit margin tends to increase if it can reduce costs while maintaining other factors constant. Similarly, the profit margin can be enhanced by increasing revenue under unchanged conditions. This boost in revenue can be achieved through price hikes, higher sales volume, or a combination of both. However, implementing price increases has its limitations to avoid losing competitiveness, and sales volume is influenced by market dynamics, including overall demand and competitor positions. Cost control also has its constraints since reducing unprofitable product lines may lead to the loss of corresponding revenues. Implementing these strategies can be complicated, making the profit margin an indicator of management and its pricing strategy.
There are various types of profit margins, with the net profit margin being the most important and commonly used. This margin deducts all expenses, including taxes, from the profit figure. When comparing profit margins of different companies, it's crucial to consider the industry in which they operate since profit margins can significantly vary across different sectors. Generally, there are different levels of profits, and consequently, different profit margins: gross profit, operating profit, and net profit.
To illustrate, let's take the example of the Emmi Group in the year 2020. The company generates revenue, also known as net sales in their income statement, and then deducts direct costs to arrive at the gross operating profit. Next, the company takes care of indirect costs, such as operating expenses for headquarters, advertising, and research and development (R&D). The resulting figure is the earnings before interest, taxes, depreciation, and amortization (EBITDA). After accounting for interest expenses and any unusual costs or non-core income, the company arrives at earnings before taxes (EBT). Finally, taxes are paid, and the remaining amount represents the net margin, which is also known as net income, net profit, or net earnings – essentially, the final result for the company.
Source: Consolidated Income Statement Emmi Group 2020, www.group.emmi.com
Excerpt from the press release of Emmi Group on March 2, 2021 (Page 3/7):
«Emmi is navigating a steady and reliable path through the crisis. Group sales exceeded CHF 3.7 billion for the first time, of which more than CHF 2.0 billion was generated outside of Switzerland. The positive sales performance confirms the robustness of Emmi’s business model, the well-balanced nature of the product and country portfolio, and the organisation’s adaptability.
In the interests of its long-term success, Emmi stepped up its strict cost management last year and also made targeted, value-creating investments in order to strengthen its innovation and growth plans for the long run. These included starting construction of a new cheese dairy in Emmen and building a state-of-the-art production facility in Brazil. Systematic optimisation of Emmi’s company portfolio is also an investment in the future. For example, the acquisition of American Indulge Desserts not only gave Emmi its own presence in the world’s largest dessert market, but also created additional distribution opportunities and economies of scale for the global dessert business. Elsewhere, the majority stake in Lácteos Caprinos was sold in order to focus resources on high-growth, high-margin companies.
Emmi also set other clear priorities alongside cost management during the crisis: to protect employees, safeguard security of supply and pursue new sales opportunities. This clear concept kept Emmi on track through the global crisis, enabling it to meet its 2020 targets for both EBIT (CHF 256.6 million) and the net profit margin (5.1 %), and in fact slightly exceed them after adjustment for the non-recurring effect described above.»
Profit Margin Calculations and Types
The following section presents different methods for calculating profit margins, using the financial data from Emmi Group as an example. Profit margins essentially indicate the percentage of the desired profit (such as gross profit, EBITDA, EBIT, or net profit) in relation to the net revenue. These profit margins are expressed as percentages in the income statement of Emmi Group, provided in the column labeled "%".
The following formula is used to calculate the gross profit margin:
In the reporting year, Emmi's gross profit increased from CHF 1,266.6 million to CHF 1,349.7 million. Despite the impact of the COVID-19 pandemic, the gross profit margin was slightly improved, reaching 36.4% in 2020 (TCHF 1,349,688 / 3,706,061). The gross profit represents how much a company earns from the direct sale of its products, without taking into account operating costs or investments when calculating the gross profit margin.
EBITDA Margin
First, the costs directly associated with the production of goods or services are deducted from the revenue. This results in the operating profit before interest, taxes, and depreciation (EBITDA). For the Emmi Group, the EBITDA amounted to TCHF 376,339 in the year 2020. Dividing the EBITDA by the net sales yields the EBITDA profit margin. For the Emmi Group, the EBITDA profit margin in 2020 was approximately 10.2% (376,339/3,706,061). The EBITDA profit margin indicates whether a company has a functioning business operation.
Operating Profit Margin or EBIT Margin
The operating profit margin is calculated by subtracting the selling, general, and administrative expenses, or operating costs, from a company's gross profit, which results in the EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization). Additionally, depreciation is deducted to obtain the operating profit before interest and taxes, commonly known as EBIT. This represents the profit generated from the ongoing operations of a company. Bankers and analysts often use the operating profit margin to evaluate a company's performance. For the Emmi Group, the operating profit margin in 2020 was approximately 6.9% (256,607 / 3,706,061).
Pre Tax Profit Margin
When the interest expenses are deducted from the operating profit before interest and taxes (EBIT), it results in the operating profit before taxes, also known as EBT (Earnings Before Taxes). Dividing the EBT by the net sales results in the pre tax profit margin. For the Emmi Group, the pre tax profit margin in 2020 was approximately 6.5% (242,257 / 3,706,061).
The net profit margin is the most crucial of all profit margins. It serves as a key figure for investors to assess how much a company's revenues exceed its expenses. The net profit is also used to calculate earnings per share. Hence, it holds particular interest for investors as it represents the profit attributed to shareholders. To calculate the net profit margin, the net profit is divided by the net sales. The net profit is determined by deducting all associated expenses, including costs for raw materials, labor, operations, rent, interest, and taxes, from the total sales. The extract from the income statement illustrates how the net profit is calculated step by step. For the Emmi Group, the net profit margin in 2020 was 5.1% (188,392 / 3,706,061).
Comparing Profit Margins
When making comparisons, relying solely on the profit margin can be misleading, as different companies operate in diverse industries with their distinct characteristics. For instance, businesses in sectors like retail and transportation may have lower profit margins, but they compensate with high sales volumes and substantial overall profits. On the other hand, luxury goods companies might have lower sales figures, but their high-profit margins on each unit contribute to significant profitability. Therefore, it is essential to consider the specific business activities and industry dynamics when analyzing profit margins.
Would you like to invest your money?
Speak to an expert.
Your first appointment is free of charge.
