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Profitability Ratio – Gross Margin, EBITDA Margin, Net Margin Hints for Marketers and Investors

Profitability ratios measure a company’s profitability stemming from financial statements. One of the main sources must be the income statement. It’s because of all the company’s main forms of income and expense.

There are countless ways to slice and dice income statements. Nevertheless, there are three main margin ratios that come up most frequently in the analysis from both investors and marketers. These ratios are the gross margin, EBITDA margin, and net margin.

Table of Contents on Profitability Ratio

What Are Profitability Ratios?

Profitability ratios are a class of financial metrics that are used to assess a business’s ability to generate earnings relative to its revenue, operating costs, balance sheet assets, or shareholders’ equity over time, using data from a specific point in time.

Profitability ratios can be compared with efficiency ratios, which consider how well a company uses its assets internally to generate income as opposed to after-cost profits. For more details, please check out this article published before.

ROA, ROE, ROC – Hints for Investors and Marketers from Financial Ratio Analysis

Looking into the trend of upward or downward profitability ratios can tell if a company is stressful or not in terms of profitability. Nevertheless, please keep in mind higher or lower profitability ratio in a way doesn’t reflect any meaningful insight if you just look into isolated company performance. Comparable company analysis is required to stand on a bigger picture and learn better insight.

Gross Profit Margin or GPM

Gross profit margin or it’s also called GPM. It is net sales less the cost of goods sold (COGS). Compared to net profit margin, it’s a topline performance metric.

In other words, it’s the amount of money a company retains after incurring the direct costs associated with producing the goods it sells and the services it provides. The higher the gross margin, the more capital a company retains, which it can then use to pay other costs or satisfy debt obligations.

Here is the equation as follows:

Gross Profit Margin = Gross Profit / Total Revenue

As you can see, if there are only gross profit figures, the number itself in isolation doesn’t tell you too much information. On the other hand, the gross profit margin can tell us how much of every $1 dollar in revenue, the company keeps after paying the cost of goods sold (COGS).

Moreover, the gross profit margin is a way to see how profitable a company is before the distortion of overhead costs, which are often more controllable than direct costs.

Hints for Marketers and Investors

Marketers: Referring to peers’ or competitors’ product gross profit margin is helpful to understand if there is any gap between your business and others. For example, if the COGS and product pricing are similar to each other, a higher profit margin implies your competitor generated more orders than yours.

Furthermore, please be sure to look into if the gross profit margin includes the customer acquisition cost or not. Notably when a company replies more on digital marketing to drive sales. If your gross profit margin calculation doesn’t include customer acquisition costs, it’s supposed to be higher than others because of leaving some room for the marketing expenses in the operational section. Otherwise, it would influence the bottom-line performance.

Investors: There are two reasons why GPM is valuable. One is it’s controllable, the other is investors can project the bottom-line margin possibility based on the gap between GPM and NPM. Along with being a higher GPM, it implies a higher NPM in the business operation, regardless of the financing section. That tells investors if a company has advantages in the business model, product, technology, and marketing.

EBITDA Margin

Further in-depth analysis after gross profit margin, it’s EBITDA margin. EBITDA margin measures how much in earnings a company is generating before interest, taxes, depreciation, and amortization, as a percentage of revenue. The margin does not include the impact of the company’s capital structure, non-cash expenses, and income taxes.

Here are the items considered in EBITDA as follows:

Here is the equation as follows:

EBITDA Margin = EBITDA / Total Revenue

Apart from the gross profit calculation, obviously, EBITDA reflects how much revenue has been eaten by operational costs so that we are able to justify whether the company is implementing a lighter investment in the operation or a heavy one. For example, any company that uses a remote operational model can save a huge amount of rental and equipment investment costs. It’s a typical case of a light operational model.

Conversely, if EBITDA is much smaller than the gross profit margin, that might imply the company leverages the income to invest in R&A, and PPE, or uses the earnings to pay off the partnership fees as well. These details can reflect the future potential growth of a company.

Hints for Marketers and Investors

Marketers: Many companies put branding and performance marketing budgets into the operating expenses section. When you come across a company where there is a huge gap between gross profit margin and EBITDA margin, product development, marketing, and customer acquisitions might occupy a certain proportion of the budget. This is a signal of potential future growth after having expenses invested in assets that can be converted into cash flow or cash flow equivalent.

Investors: EBITDA is a common and popular metric for investors because it tells how much financial leverage the company is able to make use of before the net profit margin. If a company that has raised funds by borrowing money or issuing bonds or selling equity to private investors can still have a higher net margin after having deducted the cost of debt, that means it’s a potential one to invest.

Net Profit Margin or NPM

Net Profit Margin (also known as “Bottom Line”, “Profit Margin” or “Net Profit Margin Ratio”) is a financial ratio used to calculate the percentage of profit a company produces from its total revenue. It measures the amount of net profit a company obtains per dollar of revenue gained. The net profit margin is equal to net profit (also known as net income) divided by total revenue, expressed as a percentage.

After EBITDA, the net profit margin has also considered interest and taxation.

The equation is:

Net Profit Margin (Bottom-line margin or NPM) = Net Profit / Revenue

Hints for Marketers and Investors

Marketers: It’s a good habit to observe the company’s marketing approaches with either a positive or negative net profit margin. Notably, how to strategize a PR and branding campaign while the company is in negative net profit margin because of investment earnings for future growth.

Investors: It’s used to access if a company’s management is generating enough profit from its sales and whether operating costs and overhead costs are contained. Furthermore, it tells investors how much EPS or earnings per share the company is on average if presumably the outstanding shares are not changed. Although sometimes investors look at P/B over a period of great performing macro economy, EPS is critical when the economy is shrinking because it requires the company has better market impact resistance and profitable capability

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Profitability is directly related to earnings per share of any symbol when you are finding a potential one to invest in the stock market. Compared to other sets of ratios (efficiency, liquidity, valuation), profitability is a basic and fundamental one reflecting whether a company is in healthy and sustainable finance status or not.

For any tickers or symbol you like to fetch dataset over the years to analyze the industrial profitability ratio, please visit Easy2Digital API section and subscribe to Easy2Digital newsletter by leaving a message “API number + free trial”. We will send you asap

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