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M a y 2 0 1 4 / Q U I C K P R I N T I N G 25 w w w. M y P R I N T R e s o u r c e . c o m MONEY TALK Objectives of Profit Margin Analysis The objective of margin analysis is to detect consistency or positive/negative trends in a company's earnings. To a large degree, it is the quality and growth of a company's earnings that drive its value. Profit does not "naturally" fol- low sales. Actually, profit margin can decrease with sales growth or increase with a drop in sales. When Sales Grow Some of our most prudent clients, ask us to monitor their profit margins on a continuous basis so that profit growth can be strategically planned to coin- cide with sales growth. Strategic growth is always recommended. When prop- erly managed, company profits can grow with sales. Alternately, when there is an inability to strike profits at increased sales levels, companies can go out of business. When Sales Drops Alternately, if sales drop, we step in to help minimize the effect on profit and set an order of priority for change if needed. Good examples of this were seen throughout the recession. Many companies that lost sales became leaner more profitable entities. As the economy improves, we urge them to grow strategi- cally with a close eye on profit. As a manufacturer in a "mature" indus- Profit margin can decrease with sales growth or increase with a drop in sales. By Stuart Margolis then generate profits. The success, or lack thereof, of this important manage- ment function is what determines a company's profitability. A large growth in sales will do little for a company's earnings if costs and expenses grow dis- proportionately at a higher rate. Let's look at each of the profit margin ratios individually: Gross Profit Margin—A company's cost of sales, or cost of goods sold, repre- sents the expense related to labor, raw materials and manufacturing overhead involved in its production process. This expense is deducted from the company's net sales/revenue, which results in a company's gross profit. The gross profit margin is used to analyze how effi- ciently a company is using its raw mate- rials, labor and manufacturing-related fixed assets to generate profits. A higher margin percentage is a favorable profit indicator. What we have seen is that when sales growth occurs, management should expect gross margin to increase, and when sales decrease, gross margin will decrease. What we want to see is when sales growth occurs, gross profits increase, and when sales decrease, man- agement restructures the business to keep costs in line and work to minimize the a drop in gross profit margin. External forces can also have a sub- stantial effect on raw material costs, par- P roft Margin Analysis uses percentage calculations to provide comprehensive measures of a company's proftability on a historical basis (typically 3-5 years) and in comparison to peer companies and industry benchmarks such as the Printing Industries of America Ratios available to you. Profit Margin Analysis is Critical when Sales Increase OR Decrease (continued on page 28) try, management must recognize that costs must be monitored in order to ensure a strong profit through the simple formula below of: Sales minus Costs are equal to Profit. Profit Margin Management Four profit margins can be extracted from the Income Statement: gross profit, operation profit, pretax profit and net profit. Basically, it is the amount of profit (at the gross, operating, pretax or net income level) generated by the company as a percent of the sales generated. Formulas: Gross Profit = Gross Profit Margin Net Sales (Revenue) Operating = Operating Profit Profit Margin Net Sales (Revenue) Pretax Profit = Pretax Profit Margin Net Sales (Revenue) Net Profit = Net Income Margin Net Sales (Revenue) Margins Help Keep Score The absolute numbers in the income statement are important in our profit analysis bit have limited value, which is why we must look to margin analysis to discern a company's true profitabil- ity. Measured over time, these ratios help keep score of management's abil- ity to manage costs and expenses and © Digital Vision/Thinkstock QP_25-28_0514 MoneyT-SalesC.indd 25 4/15/14 5:06 PM