2.6. Margins and Efficiency
Lesson objective
Understand how much remains after each major cost category.
Gross margin measures what remains after direct costs. Operating margin subtracts operating expenses. Net margin includes interest, taxes, and other effects.
Rising margins may indicate pricing power, scale, or cost discipline. They may also improve temporarily because of cuts that weaken future growth. Falling margins may reflect deliberate investment or competitive pressure.
Compare companies with similar business models. A supermarket and a software company have fundamentally different cost structures.
Build the margin ladder
Gross margin = Gross profit ÷ Revenue
Operating margin = Operating income ÷ Revenue
Net margin = Net income ÷ Revenue
Margin ladder
Revenue 100 → Gross profit 60 → Operating income 25 → Net income 18. The margins are 60%, 25%, and 18% respectively.
Rising margins can reflect pricing, scale, mix, or temporary cost cuts. Falling margins can reflect competition, investment, inflation, or weaker mix. Connect the percentage to the business cause.
Essential terms
| Term | Practical meaning | |---|---| | Gross Margin | Gross Profit divided by Revenue. | | Operating Margin | Operating Income divided by Revenue. | | Net Margin | Net Income divided by Revenue. |
In Finzati
Company Snapshot displays Gross, Operating, and Profit Margin.
What you should remember
- Margins are most comparable among similar business models.
- Any improvement should have an economic explanation.
Practice
Choose two peers in Finzati and compare their three main margins.