Key data: Evolution Profit margin

The profit margin is the ratio of profit to revenue. Profit margin growth is often the fastest reacting parameter in conjunction with the course of business. In that sense, profit margin functions as an early indicator.

Profit margin can be an indicator of the management’s strategy. A falling profit margin could indicate that the business is trying hard to increase sales in order to capture more market share, even if it means that the profit margin suffers for a few years. Once the business has captured a larger market share the sales efforts can eventually be decreased while attempts are made to keep down other costs. Higher sales levels give a company the bargaining power to stipulate lower purchase prices amongst other things. Once the business has secured a larger market share the emphasis can be moved back towards trying to increase the profit margin.

A profit margin can of course not increase exponentially. The management of a business needs to try to achieve the highest possible sales without losing sight of the profit margin. The emphasis can sometimes be changed from going for the highest possible profit margin to getting the highest possible sales at the expense of the profit margin.

If a falling profit margin is not accompanied by strongly increasing revenue with increased earnings, then there is obviously something wrong. This is often the result of some cutthroat competition within the sector. It is obviously a bad sign if a falling profit margin is the result of sharply increasing costs without strongly increasing revenues. A reorganization and restructuring of the business would then be imperative. A falling profit margin without an increase in the revenue should trigger alarm bells for an investor.

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