Lesson 6 of 12 · 2 min · Valuation
Margins
How much of every dollar of sales the business keeps.
A margin is the part of each dollar of sales that is left after costs. Lemon Co sells $12.5 million of lemonade a year.
Lemons, sugar and cups cost $5 million. What remains, $7.5 million, is the gross profit: a gross margin of 60%.
Take off wages, rent and everything else, and $2.5 million of operating profit is left. That is an operating margin of 20%. After interest and tax, 12% ends up as profit.
The level tells you about the business. The trend tells you about its fight with competitors. Margins that shrink year after year usually mean someone is winning customers away.
Compare margins within an industry, not across. A supermarket with a 3% margin can be excellent. A software company with 3% would be struggling.
Quick question
A company’s sales grow 10% a year, but its operating margin falls from 20% to 10% over five years. What is most likely going on?
- It is getting more efficient
- It is buying growth with lower prices or higher costs
- Nothing, margins do not matter
Show the answer
It is buying growth with lower prices or higher costs
Sales up, margin halved: each new dollar of sales brings in less profit. Often that means price cuts, rising costs, or tougher competition.
Keep this one
Watch the trend, not just the level.
Where this comes from
Standard income statement margins: gross, operating and net. Typical margins vary a lot by industry. Lemon Co is invented for teaching.