What is a company’s profit margin and why is it crucial in 2023’s high-inflation environment?

Nick Sundich Nick Sundich, May 4, 2023

In the high inflationary environment we’re in, investors will hear companies talk about margins. What are companies talking about? Why are margins so important? And how can companies maintain them in a high-inflationary environment.

 

 

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What is a company’s margin?

A company’s margin, also known as profit margin, is the ratio of net profit to sales revenue. Essentially, it is the percentage of sales that turn into profit.This ratio is used as an indicator of a company’s profitability. A higher margin signifies that the company is maximising its profitability, while a lower margin signals that the company may need to reevaluate its operations and expenses.

For the record, there’s no ‘one-size-fits-all’ yard stick that suggests what is an acceptable margin – although shareholders would think the higher the better. Still, it is not unreasonable to compare companies in the same industry to one another and suggest one company is better than another or to find an industry average and to use that as a yard stick.

 

Other margins?

There are different types of margins that companies can consider, such as gross margin, operating margin, as well as EBITDA and EBIT margins.

Gross margin is the percentage of revenue that remains after accounting for the cost of goods sold (COGS). Operating margin is the percentage of revenue that remains after accounting for both COGS and operating expenses.

EBITDA and EBIT margins are the percentage of revenues left after when EBITDA and EBIT is considered. Naturally, all these will be higher than the NPAT margin.

 

Why do margins matter (generally)?

It is important for companies to understand their margins in order to make informed decisions about pricing, expenses, and investments. A low margin may indicate that the company needs to adjust its pricing strategy or cut costs, while a high margin may allow the company to consider expanding its operations or investing in new technologies.

 

Why are they so important now?

In a high-inflation environment, a company’s profit margin play a crucial role in ensuring the sustainability and profitability of a business. Inflation causes prices to rise and currency to lose its value over time. This means that the cost of goods and services also increases, making it difficult for businesses to maintain their profitability unless they adjust their margins accordingly. They also act as a buffer against rising costs. For example, if a business has a profit margin of 20%, and the cost of producing a product increases by 10%, the business can adjust its price by 10% to maintain the same profit margin.

However, if the profit margin is already low, the business may have to increase its prices significantly, risking losing customers to competitors and ultimately hurting its bottom line. Whichever of those options a company chooses all depends on its competitive position as well as whether or not the company’s good or service is a staple or discretionary – in other words one that consumers can easily sacrifice and maintain a reasonable quality of life.

Inflation can also impact business operations in other ways. For instance, the cost of borrowing money to fund business operations increases in a high-inflation environment. This means that businesses with a low profit margin may find it challenging to access financing for expansion or other activities. Furthermore, high inflation can create uncertainty in the market, making it difficult for businesses to plan for the future. Businesses may have to deal with unpredictable demand, volatile currency exchange rates, and increased competition from domestic and international players.

By maintaining a healthy margin, businesses can increase their resilience to such external shocks and create a cushion to absorb unexpected expenses or losses.

 

Keep your eye on margins

A company’s margin is a crucial indicator of profitability and financial health. By keeping a close eye on their margins and making strategic decisions, companies can ensure long-term success and growth. A Margin is particularly in a high-inflation environment because they enable businesses to adjust to rising costs and maintain their profitability.

 

 

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