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Evan Davis on... corporate profit margins

Updated Thursday, 1st October 2009

The Bottom Line’s Evan Davis accounts for the prices charged by companies and explains the corporate profit margin.

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It’s very common for the public at large to think about corporate profitability in terms of the profit margin. They may not use that phrase, but it’s a very common way of looking at it. A company sells something for a pound, has bought it for 50p and is making a 50% margin. It’s very common for business people to do so too. There’s the important distinction between the gross margin and the net margin. The gross margin is the money the company keeps after paying the direct production costs or purchase costs of the product it sells. The net margin is the amount the company keeps after the direct purchase costs and all the other costs of doing the business; the overheads, the advertising and all those other things. Very useful concepts, wonderful; it’s encapsulating how profitable a business is.

I once heard someone grumble. He was looking at the margin of a posh café selling coffee. He said a cup of coffee can’t possibly, generously, cost more than 50p, and they’re selling it for two pounds, how much of a rip off is that? Well, of course the margin is a very useful concept, but it’s not the only thing that you should look at when you're thinking about profitability. You may have a very big gross margin but if your overheads are very big, if the cost of the rent of the coffee shop, for example, is high, you can still be making a loss. And of course, a company may be having a big net margin, but if it isn’t selling very much, well then, it’s not going to have very big profits. It might have a high percentage profit rate, but it’s not actually going to bring home much cash. So it’s always important to know that there’s more to making money than the margin.

Well, that’s my view, but you can join the debate with the Open University.

 

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