Net margin and operating efficiency

Margins measure how much of each unit of revenue survives as profit after costs. They reveal pricing power and cost discipline, and they make companies of very different sizes directly comparable.

The main margins

Gross margin     = Gross profit / Revenue
Operating margin = Operating profit (EBIT) / Revenue
Net margin       = Net income / Revenue

A worked example

From our income statement — revenue 1,000, gross profit 400, EBIT 250, net income 150:

Gross margin     = 400 / 1,000 = 40%
Operating margin = 250 / 1,000 = 25%
Net margin       = 150 / 1,000 = 15%

Each step down shows where money is lost: 40 cents of every sales dollar survive the cost of goods, 25 survive operating expenses, and 15 reach shareholders after interest and tax.

How to read margins

• Compare within an industry. A supermarket lives on 2-3% net margins; a software firm may run 25%. Cross-sector comparison is meaningless.
• Watch the trend. Margins expanding over several years signal growing pricing power or scale; margins shrinking signal competition or rising costs.
• A wide gap between operating and net margin points to heavy interest costs (debt) or an unusual tax situation — worth investigating.

Stable, high margins are a hallmark of a business with a real competitive advantage.