Key financial ratios, growth rates, and rates of return - Margins

12 important questions on Key financial ratios, growth rates, and rates of return - Margins

A margin is something usually divided by what?

Revenues

What do margins express?

The relative size of profitability versus the size of a business.

What are the five key margins?

  1. Gross margin
  2. Contribution margin
  3. EBITDA margin
  4. EBIT margin
  5. Net profit margin
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What does a company have to do when it has a larger gross margin?

The company has to optimise their cost structure.

What is the formula of contribution margin?

EBITDA / (revenues - COGS and other obvious variable costs)

EBITDA / gross profit

What does the contribution margin measure?

The operational profitability of a business' own value-add.

Why is the contribution margin important for companies that predominantly resell or does something in between meaning added value to its customers?

Because it measures the operational profitability on this own value-add.

EBITDA margin is a good approximation of an operational cashflow ratio versus sales, but also a good figure to compare profits amongst various businesses?

Because EBITDA is the profit prior to taking into account costs for depreciation, financing costs, and taxes, which are all costs that can vary from business to business.

What is the EBIT margin?

It is the most commonly used margin to get a profitability of a business, i.e. Including depreciation and amortisation costs as a proxy for the profitability that the market allows a business to have in its current management style.

How can a business change its financing structure and hence also the costs below the EBIT line, without changing the business, prices, volumes, and value proposition towards its customers?

Costs after EBIT within an income statement are financing costs and taxes, both of which are interlinked (interest costs are tax-deductible), and which therefore can be somewhat managed by corporate financiers.

What does net profit margin express?

The % of sales that is left as an income for shareholders, after all other costs have been subtracted.

What does net profit minus dividends directly adds to?

To the book value of a business, hence to shareholders' equity.

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