3 types of profit margin to look before investing in a company

Why we are investing in a stock market? Most of you agree on the point, to get a high profit in comparison to other investment options. Similarly, a business sells its services or products to get a high profit.

In a simple word, Profit is an amount that left with a company after paying for its expenses. I think it is clear how important a profit is for businesses.  A healthy business can also categorise by considering and comparing profit margins of different industries in the same market segment to find the high potential company which is differentiating their products and services from their rest of the competitors.

A profit margin can further divided into three major types to find the company capability on different parameters. These are:-
1Gross profit margin – The gross profit margin is a margin amount that left after paying costs involved in producing the product. It can calculate by subtracting the total cost of goods sold from the total revenue of the company. It will be more clear by considering an example: Suppose a company name as ABC which is involved in manufacturing of earthmoving and construction equipment reported revenue of INR 70 billion, and its cost of goods sold is INR 40 billion. the gross profit margin can calculate by subtracting INR 40 billion from INR 70  billion and come as INR 30 billion. Now, divide the company’s INR 30 billion gross profit by its total revenue of INR 70 billion and multiply by 100 to calculate the gross margin in percentage which will come as a 42.8%. the gross margin in percentage states that after paying for direct costs, such as steel and labourers’ time, ABC kept nearly 42.4 paise of every rupee in revenue.

Note:- Gross profit margin is not useful to analyse the performance of software and Internet companies. The reason being the cost involved in producing software is overhead which is indirect costs. This is why? the software companies have very large gross profit margins but its accurate picture reflects by studying the operating profit margin.

2. Operating profit margin – Operating profit is one step ahead than the gross profit as it not only considers the company’s direct costs but indirect costs, too. It states how much the company keeps revenue after paying direct costs and overhead expenses. To calculate the operating profit margin, the operating profit divided by revenue. Operating profit margins is an important indicator to calculate the company’s profitability concerning its core business.

3. Net Profit Margin – A company’s net profit is the most comprehensive measure of Profitability. Net profit is the total amount left with the company after paying all its costs and expenses. The net profit margin can calculate by dividing net profit with total revenue, Just like net profit, companies can lose money, too which is called as a net loss.

Profit margin is one of the most important parameters to find the companies with a competitive advantage and the best thing is, it is easily available in the annual report of the company and various financial sites.

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