Profit margin contextualizing

Hi there,

1) If profit margin is high, it means we have high revenues and low costs, right? 

It depends on what exactly the profit margin is referring to (eg net or gross). Plus, you don’t necessarily need to have both higher revenues and lower costs compared to a benchmark at the same time, one of the conditions may be sufficient.

Net profit margin is the ratio of Net Income / Revenues so, compared to a benchmark, if we have:

• Higher revenues with the same (or lower) costs or 
• Lower costs with the same (or higher) revenues 

we will have a higher profit margin.

However, gross profit margin is Gross Profit / Revenues. This means that you could have higher non-COGS costs and still have a higher gross profit margin compared to a benchmark, because non-COGS costs are not included in gross profit.

2) If it is low, does it mean that we either have 1) high revenues and high costs or 2) low revenues and low costs or 3) low revenues and high costs?

Assuming that the metric is Net profit margin, it means that Net Income / Revenues is lower than the benchmark.

This could happen in different situations:

• Lower revenues and the same (or higher) costs
• Higher costs and the same (or lower) revenues
• Higher revenues and higher costs such that Net Income / Revenues is lower
• Lower revenues and lower costs such that Net Income / Revenues is lower

Hope this helps,

Francesco

Hmm… you can't put things in this way. The whole framing is very wrong.

First, there is no such thing as a “high profit margin” in itself. You have margins that are high when you compare to competitors or to other industries (or to your own historical numbers). Second, you are comparing a ratio (profit margin) with absolute numbers - you just can't do that.

Moreover, high revenues means nothing in terms of margin. You can have huge revenues and lose a lot of money (UBER, anyone?). You can be a very small company and have a huge profit margin. I met one a few years ago that had less than 2M€ revenue but had >60% EBITDA margins… Best in class performance in the whole country.

Low costs… compared to what exactly? You may have high margins and also higher costs if your business model is built that way (e.g. built to provide VALUE). Just look at MBB vs. other consulting firms. They pay more, but still they have higher margins…

So: 1) you can have high margins and yet have higher costs than your competitors… 2) you can have high margins and lower revenues than your competitors… 

You need a different approach for this. Hope this was helpful. ;)
 

Hey,

I wont repeat what other coaches have already said. But here's a little bit of clarification:

Margin is an interplay between revenue and cost and will vary from one industry to another. Margin generally is used as an indicator of how well a company is controlling its costs. So the higher it is, the better the company performs & grows. What could be high margin in one industry (e.g. commodity or grocery) could very low in another (e.g. professional services). So, margin is relative and not absolute. 

It is important to compare only the profit margin of companies within the same industry. Different business models in various industries results in widely varying margins.

Hi there,

This is indeed an interesting question which is probably relevant for quite a lot of users, so I am happy to provide my perspective on it:

• Generally speaking, since the profit margin is just the ratio of revenues and costs, both factors might lead to a high ratio thus profit margin. You could, for instance, have relatively high revenues and medium costs or medium revenues and low costs. When the profit margin is low, the two factors will have just the opposity relation to each other.
• Moreover, I would advise you to clarify with the interviewer what profit margin we are talking about, e.g. gross profit margin vs. operating margin vs. pretax margin vs. net profit margin. All of these ratios are profit margins yet the approach to calculate them would be different.

In case you want a more detailed discussion on the quantitative questions part of case studies, please feel free to contact me directly.

I hope this helps,

Hagen

Hi there,

Kind of. I don't really like thinking about it this way, but this is ostensibly correct. (As in, we could have medium revenues but super low costs, if you want to get pendantic!)

As a metaphor, would you talk about someone who has a low savings rate as low income and low spend, high income and high spend, or low income and high spend? Sure! But it's also overcomplicating it :)

Essentially, margins are the split between the revenues you bring in and the costs to get those revenues.