Margin Ratios

What are Margin Ratios?

Margin ratios measure a company’s ability to turn its sales into profits. Standalone figures provide only a snapshot and are in some way meaningless without a benchmark. Margin ratios have applications in valuation, credit analysis, and company performance.

Key Learning Points

• Margin ratios help analyze the relationship between a company’s earnings or profits and sales
• Key profitability ratios are Gross margin, EBIT margin, EBITDA margin, and net margin

Profitability Margins

Margins present a company’s profits as a percentage of its sales and are useful for comparison to peers. Below are the most common margins:

Gross Margin

Gross margin tells us how much profit remains after removing the direct cost of sales, COGS, but before less direct costs like sales and marketing. Typically, a company with high value add like a service company will have a high gross margin, while a trading business adds less value to the product and therefore typically has low gross margin.

Gross margin = Gross Profit / Sales

EBIT Margin

Earnings before interest and taxes (EBIT) is a figure which shows the profitability of a company from its operations after excluding non-recurring items. Excluding these items can improve comparability as well as providing a useful starting point for predicting future profitability.

EBIT margin helps to understand the profits generated from a company’s core operations and ignores the effects of a company’s financing decisions and taxes.

EBIT Margin = EBIT/Sales

EBITDA Margin

EBITDA margin shows the recurring operating profit before the impact of depreciation and amortization as a percentage of sales. Depreciation and amortization expenses can vary between companies depending on their accounting policies. Using EBITDA removes this effect.

EBITDA Margin = EBITDA/Sales

Net Margin

Net margin measures the company’s net income as a percentage of revenues.  is the profit after all expenses have been deducted for the period. Net margin is calculated as:

Net margin = Net income/Sales

Net income can be affected by one-time gains or losses. For valuation purposes, an analyst will “clean” the net income and remove the impact of non-recurring items.