Profit Margin
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Gross Margin - measures the amount of each sales dollar available to cover operating expenses, including selling and administrative expenses, other expenses and income tax expenses.
Implications of Gross Margin Percentage Changes
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Sales prices not changing at the same rate as unit costs
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Sales prices increasing/decreasing due to intensity of competition
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Mix of products sold shifting to products with lower/higher margins
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Changes in inventory shrinkage
Gross Profit = Sales - Cost of Sales
Gross Margin = Gross Profit ፥ Net Sales
Operating Margin - measures the amount of each dollar available to cover interest expense, other expenses and income tax expense. It is a key metric for service firms because firms do not have cost of sales, and therefore have no Gross Margin.
Operating Profit Margin = Income from Operations ፥ Net Sales
Net Operating Profit After Tax (NOPAT) - it calculates how much income would remain after taxes if the company were taxed on all its operating income. Through this, two or more companies’ performance can be compared regardless of how the companies choose to finance themselves.
NOPAT = Operating Profit x (1 - Tax Rate)
NOPAT Ratio = NOPAT ፥ Sales
Profit Margin - measures the amount of each sales dollar earned for the common stockholders of the company.
Each margin has more meaning when it is compared to the prior period, a competitor’s margins, or an industry average. Each ratio is determined by the expense component used to calculate it. The following table identifies each cost of category and its impact on each ratio:
Practice Exercises
1. The profit figure that is preferred in connection with the analysis of a department
A.Operating Income
B. Income before income tax
C. Net income
D. Taxable Profit
2. A company’s sales margin:
A. Must, by definition, be greater than the firm’s net income
B. Has basically the same meaning as the term “contribution margin”
C. s computed by dividing sales revenue into income
D. Shows the sales dollars generated from each dollar of income
3. A company has a degree of leverage of 2. How much should the company change its sales to achieve a 20% increase in operating income?
A. 10% increase
B. 10% decrease
C. 40% decrease
D. 40% increase
4. Mary buys a car from a mean salesman who charges her 12% over the original price of a $15,000 car. Luke buys the same car from a much nicer salesman who gives him an 8% discount off of the original price. How much more does Mary spend on the car than Luke does?
A. $1200
B. $2500
C. $3000
D. $2000
5. What percentage of profit is made on a product sold for $20 if its overall production cost was $17.50?
A. 46.67%
B. 14.29%
C. 25%
D. 87.5%
6-8 compute the following:
6. Gross Profit
7.Operating Margin
8. Profit Margin
9. The difference between a company's sales and cost of goods sold is referred to as the:
A. Gross profit
B. Net income
C. Retained earnings
D. Gain on the sale
10. Net Sales - Cost of Goods Sold is equal to
A. Gross Expenses
B. Gross Profit
C. Operating Expenses
D. Net Income from Operations.
Answer Key:
1. A
2. C
3. A
20% ፥ 2
4. C
Solutions:
12% of 15,000 is 0.12 * 15,000 = 1800. 8% of 15,000 is 0.08 * 15,000 = 1200; therefore in total, Mary spent 1800 + 1200 = $3000
5. B
Explanation:
To find the profit percentage, you must first determine the amount of profit made on this transaction. If the sale price was $20 and the production cost $17.50, then the profit made was: 20 -17.5 = $2.50. The profit percentage is determined by dividing the amount of profit made by the original price, or 2.5 / 17.5 = (approx.) 0.14286
6. 44.0%
Solutions:
5,719 ፥ 11,776
7. 15.9%
Solutions:
1,868 ፥ 11,776
8. 9.4%
Solutions:
1,103 ፥ 11,776
9. A
10. B
References:
Vipond, T. (2022, November 26). Profit Margin. Corporate Finance Institute; Corporate Finance
Institute. https://corporatefinanceinstitute.com/resources/accounting/profit-margin/