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Ian

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6

Profit and Profit Margin

Hi PrepLounge community.

I know that Profit = Revenue - Cost, and Profit Margin = (Revenue - Cost)/Revenue.
I came across a case where the Revenues have decreased by 5% over the last year, hence this translated mechanically into a decrease in profit. However, the Profit Margin remains unchanged.

May I know why this is the case? Many thanks!

Hi PrepLounge community.

I know that Profit = Revenue - Cost, and Profit Margin = (Revenue - Cost)/Revenue.
I came across a case where the Revenues have decreased by 5% over the last year, hence this translated mechanically into a decrease in profit. However, the Profit Margin remains unchanged.

May I know why this is the case? Many thanks!

6 answers

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Book a coaching with Ian

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Hi there,

The key here is that your Profit definition is in the aggregate.

Profit margin is generally on a per unit basis.

Here we are assuming there aren't really fixed costs.

=============================================

Think about it this way.

If we sell Lemonade and make 10 cents for every dollar cup sold, our profit margin is 10%.

This year we sell 100 cups, and see a profit of $10.

Next year we fell fewer cups, only 50. We see profits of $5 (exactly half). Revenue was cut in half, profit was cut in half, but profit margin is still 10% ( $5/$50)

Hi there,

The key here is that your Profit definition is in the aggregate.

Profit margin is generally on a per unit basis.

Here we are assuming there aren't really fixed costs.

=============================================

Think about it this way.

If we sell Lemonade and make 10 cents for every dollar cup sold, our profit margin is 10%.

This year we sell 100 cups, and see a profit of $10.

Next year we fell fewer cups, only 50. We see profits of $5 (exactly half). Revenue was cut in half, profit was cut in half, but profit margin is still 10% ( $5/$50)

(edited)

Book a coaching with Antonello

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Your formulas are correct. Profit margin is the profit in percentage on revenue: if it does not change but revenues decrease it means that costs are decreasing proportionally. The profit in absolute amount will be lower. With this practical example it will be clearer:

YEAR 1
Revenue: $100
Cost: $60
-> Profit: $40
-> Profit margin: 40%

YEAR 2
Revenue: $50
Cost: $30
-> Profit: $20
-> Profit margin: 40%

As you can see, even if the profit margin is the same, the total profit is declining

Hope it helps,
Antonello

Your formulas are correct. Profit margin is the profit in percentage on revenue: if it does not change but revenues decrease it means that costs are decreasing proportionally. The profit in absolute amount will be lower. With this practical example it will be clearer:

YEAR 1
Revenue: $100
Cost: $60
-> Profit: $40
-> Profit margin: 40%

YEAR 2
Revenue: $50
Cost: $30
-> Profit: $20
-> Profit margin: 40%

As you can see, even if the profit margin is the same, the total profit is declining

Hope it helps,
Antonello

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Margins and absolute numbers are not related. If a certain product has a certain profit margin, for example, and you decrease quantitiy, this will lead to decreased revenues while the actual profit margin stays the same, however at a lower absolute level.

Margins and absolute numbers are not related. If a certain product has a certain profit margin, for example, and you decrease quantitiy, this will lead to decreased revenues while the actual profit margin stays the same, however at a lower absolute level.

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Short answer is: Total cost must have decreased as well (either due to changes in product mix, decrease in volume or decrease in unit cost). Otherwise this would not be possible mathematically.

Short answer is: Total cost must have decreased as well (either due to changes in product mix, decrease in volume or decrease in unit cost). Otherwise this would not be possible mathematically.

Hi there,

Did you check if it is a product mix issue?

Here is an example

Year 1:

Product A: revenues: 100, profits 10

Product B: revenues 100, profits 10

Overall revenues = 100 + 100 = 200

Overall profits = 20

profit margin for year 1: 20/200= 10%

Year 2:

Product A: revenues: 80, profits 8

Product B: revenues 110, profits 11

Overall revenues = 80 + 110 = 190 (decrease of 5% from year 1)

Overall profits = 8 + 11 = 19

profit margin = 19/190 = 10% -> the same profit margin as year 1 even though the revenues have decreased by 5%.

I hope it helps

Hi there,

Did you check if it is a product mix issue?

Here is an example

Year 1:

Product A: revenues: 100, profits 10

Product B: revenues 100, profits 10

Overall revenues = 100 + 100 = 200

Overall profits = 20

profit margin for year 1: 20/200= 10%

Year 2:

Product A: revenues: 80, profits 8

Product B: revenues 110, profits 11

Overall revenues = 80 + 110 = 190 (decrease of 5% from year 1)

Overall profits = 8 + 11 = 19

profit margin = 19/190 = 10% -> the same profit margin as year 1 even though the revenues have decreased by 5%.

I hope it helps

(edited)

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Hello!

Your formulas are correct!

One key thing in these type of puzzling questions is to ask for a breakdown of the data, since here you are it all aggregated (all the business line together) and many times the key is in looking at the different businesses.

Hope it helps!

Cheers,

Clara

Hello!

Your formulas are correct!

One key thing in these type of puzzling questions is to ask for a breakdown of the data, since here you are it all aggregated (all the business line together) and many times the key is in looking at the different businesses.

Hope it helps!

Cheers,

Clara

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