6. Profit Margins

Finally, financial analysts usually also compute profit margins. Margins are earnings expressed as a percentage of sale. The three key profitability margins are gross profit margin, operating profit margin, and net profit margin:

 

Gross profit margin = \( \frac{Sales - COGS}{Sales} = \frac{\text{Gross profit}}{Sales} \).

 
Operating profit margin = \( \frac{EBIT}{Sales} \).

 

Net profit margin = \( \frac{\text{Net income}}{Sales} \).

 

The Gross profit margin indicates the profit a company makes on its cost of sales and therefore tells us how efficiently the company manages labor and supply in the production process. By relating EBIT to sales, the Operating profit margin shows how successful a company was at generating income from operating the business. Finally, the Net profit margin compares net income with sales. Because net income reflect the costs from all aspects of the business, including interest expenses and taxes, the net profit margin tells us something about how effectively the management runs the overall business.

We have encountered these profit margins already when discussing the common-size income statement. In the case of Hershey in 2015, have the following information from the income statement (in millions of USD):

  • Net sales in 2015: 7'386.6
  • COGS in 2015: 4004.0
  • EBIT in 2015: 1'037.8
  • Net income in 2015: 513.0

Consequently, the firm's relevant profit margins are:

 

Gross profit margin = \( \frac{Sales - COGS}{Sales} = \frac{7'386.6 - 7'386.6}{7'386.6} \) = 45.8%.

 

Operating profit margin = \( \frac{EBIT}{Sales} = \frac{1'037.8}{7'386.6} \) = 14.0%.

 

Net profit margin = \( \frac{\text{Net income}}{Sales} = \frac{513.0}{7'386.6} \) = 6.9%.