How to calculate margins

Written by bradley james bryant
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How to calculate margins
Financial analysts primarily look at three levels of margin. (profit with calculator image by Kirubeshwaran from Fotolia.com)

Margin is a percentage of the whole. In financial terms, the "whole" is total sales, and margin is used to refer to the amount of profit made. Financial analysts primarily look at three levels of margin: gross profit margin (GM); operating profit margin (OM); and net income margin (NI). All can be easily computed using the income statement found in the Form 10(k).

Skill level:
Moderate

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Instructions

  1. 1

    Define gross margin (GM). Gross margin is defined as a company's total revenues minus its cost of goods sold, divided by total revenue. Expressed as a percentage, gross margin represents the percentage of total revenue that the company retains after paying for the cost of goods sold (CGS). This is usually the second line item on the income statement.

  2. 2

    Walk through a gross margin (GM) example. If a furniture manufacturing company makes £650 in sales and the cost of sales (inventory) is £390, gross profit = sales ($1,000) minus cost of sales ($600), or £260. To calculate gross margin, take gross profit (£260) and divide by total sales (£650). The equation is $400 / $1,000, or .40. Multiply by 100 to make it a percentage. The equation is .40 x 100 = 40 per cent. If a company's gross margin for the most recent quarter is 40 per cent, this means it retains 20p from each dollar of revenue generated from sales.

  3. 3

    Define operating margin (OM). Operating margin is a measure of the proportion of a company's revenue left over before interest and taxes and after operating expenses, such as wages, benefits and travel. If a company's operating margin is increasing, it is earning more per dollar of sales.

  4. 4

    Calculate operating margin. Using the same example, assume that overhead, rents, wages and benefits (operating expenses) equals £130. Operating profit = gross profit (£260) minus operating expenses (£130). The equation is $400 minus £130 = £130. To calculate operating margin, take the operating profit ($200) and divide by total sales (£650). The equation is $200 / $1,000 or .20. Multiply by 100 to make it a percentage. The equation is .20 x 100 = 20 per cent. If a company's operating margin for the most recent quarter is 20 per cent, this means it retains 10p from each dollar of revenue generated from sales.

  5. 5

    Define net income margin (NI). Net income margin is calculated by dividing net income by total sales. Net income is operating profit minus interest minus taxes. This number can be found on the income statement.

  6. 6

    Calculate net income margin. Using the same example, assume that interest expense is £32 and tax expense is £32. Net income = operating profit ($200) minus taxes ($50) minus interest ($50) = £65. The equation is £130 minus £32 minus £32 = £65. To calculate net profit margin, take net income profit (£65) and divide by total sales (£650). The equation is $100 / $1,000, or .10. Multiply by 100 to make it a percentage. The equation is .10 x 100 = 10 per cent. If a company's operating margin for the most recent quarter is 10 per cent, this means it retains 0 from each dollar of revenue generated from sales.

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