A:

The most widely used financial margins are calculated based on income statements and include metrics such as gross profit margin, operating profit margin, net income margin, EBITDA margin and contribution margin. Investors also use margins based on cash flows, including the operating cash flow margin. Finally, analysts often calculate industry-specific margins, such as net interest margin for the companies in the banking sector.

When an investor considers investing in a company, he should pay special attention to financial margins. These ratios demonstrate the company's ability to contain its costs and generate profits and cash flows that it can use to make capital investments or payouts in the form of dividends or share buybacks. Margins are presented in percentage terms and provide for better comparisons across different time periods for a company. An investor can also compare a company's margins against its industry peers.

An income statement contains four levels of profitability margins based on gross profits, operating income, earnings before taxes and net income. These margins convey how much profits the company generated as a percent of sales. Gross profit margin tells investors if the company's average markup on goods and services covers its cost of goods sold (COGS).

Operating income margin indicates the company's ability to cover its production costs as well as sales, general and administrative expenses, and research and development expenditures. Operating income margin is a widely used metric; the operating income represent pretax money based on accrual accounting available to the company's common shareholders and creditors.

Investors often use the earnings before taxes margin to gauge how much profits the company generated before paying out a portion of its earnings to tax authorities. Common shareholders pay special attention to net income margin, because this metric assesses the company's effectiveness to generate earnings for its shareholders.

Other popular margins among investors include EBITDA margin and contribution margin. EBITDA margin measures how much profits the company earned as a percent of revenue before paying out any interest, taxes, depreciation and amortization. This margin is similar to cash flow margin, since depreciation and amortization do not represent cash outflows. Operating cash flow margin is another important metric that reveals how much cash flow from operations as a percent of revenues the company generated in a given period.

Contribution margin is calculated as the revenues minus variable costs divided by the total revenue. The contribution margin provides investors with a measure of the operating leverage present in the company. Typically, companies with high contribution margins have higher degrees of operating leverage and are considered very risky. This metric is sometimes difficult to calculate; very few companies disclose the breakdown of their costs between variable and fixed components.

Analysts calculate industry-specific financial margins, such as net interest margin for companies in the banking sector. Calculated as interest income minus interest expense divided by the bank's loans to customers, net interest margin is most helpful in gauging the bank's ability to generate income on its core operating assets.

RELATED FAQS
  1. What's the difference between profit margin and operating margin?

    Find out the differences between a company's gross profit margin, net profit margin and operating margin, and what each metric ... Read Answer >>
  2. What is the difference between operating margin and profit margin?

    Understand the difference between operating margin and profit margin in relation to evaluating a company's profitability ... Read Answer >>
  3. What is the difference between operating margin and contribution margin?

    Understand the difference between two measures of profitability, operating margin and contribution margin, and the purpose ... Read Answer >>
  4. What is considered a healthy operating profit margin?

    Operating profit margin is one of the key profitability ratios that investors and analysts consider when evaluating a company. ... Read Answer >>
  5. What is the difference between operating margin and gross margin?

    Discover the main differences between operating margin and gross margin, and how investors and analysts interpret each differently. Read Answer >>
  6. What is the difference between gross margin and operating margin?

    Understand the difference between gross margin and operating margin in relation to evaluating a company's overall profitability ... Read Answer >>
Related Articles
  1. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
  2. Managing Wealth

    What's a Good Profit Margin for a Mature Business?

    How to determine if the amount you clear dovetails with the competition.
  3. Investing

    Buying on Margin

    When an investor buys on margin, he or she pays a portion of the stock price – called the margin -- and borrows the rest from a stockbroker. The purchased stocks then serve as collateral for ...
  4. Investing

    Explaining Initial Margin

    Initial margin is the percentage of a stock’s price an investor must have in his account to buy that stock on margin.
  5. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  6. Financial Advisor

    Margin Call

    Find out why a margin call is so important to investors.
RELATED TERMS
  1. Operating Margin

    A ratio used to measure a company's pricing strategy and operating ...
  2. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
  3. Profit Margin

    Profit margin is part of a category of profitability ratios calculated ...
  4. Marginal Profit

    Marginal profit is the profit earned by a firm or individual ...
  5. Initial Margin

    The percentage of the purchase price of securities (that can ...
  6. Gross Margin

    A company's total sales revenue minus its cost of goods sold, ...
Hot Definitions
  1. Stagflation

    A condition of slow economic growth and relatively high unemployment - a time of stagnation - accompanied by a rise in prices, ...
  2. Notional Value

    The total value of a leveraged position's assets. This term is commonly used in the options, futures and currency markets ...
  3. Interest Expense

    The cost incurred by an entity for borrowed funds. Interest expense is a non-operating expense shown on the income statement. ...
  4. Call Option

    An agreement that gives an investor the right (but not the obligation) to buy a stock, bond, commodity, or other instrument ...
  5. Pro-Rata

    Used to describe a proportionate allocation. A method of assigning an amount to a fraction, according to its share of the ...
  6. Private Placement

    The sale of securities to a relatively small number of select investors as a way of raising capital.
Trading Center