Margins on the P&L
Read each line as a percent of revenue, and spot when bigger dollars hide a worse business.
In your head, jot if needed · no calculator why?
Opens at level 19. You're level 1. You can read and practice here now.
the idea
A margin is a P&L line as a percent of revenue: the share of each sales dollar the business keeps at that step. Gross margin is gross profit divided by revenue. Operating margin and net margin do the same with operating profit and net income.
Margins let you compare months of different sizes. More profit dollars can still mean a weaker business, if each sales dollar keeps less. And profit does not track sales: when sales grow 20%, profit can grow faster, grow slower, or fall, depending on the margin and the costs.
techniques
Divide by revenue
- Take the profit line the question names.
- Divide it by revenue, never by costs, and multiply by 100.
- To compare months, work out both margins first.
worked example
Revenue is $60,000 and gross profit is $21,000. What is the gross margin?
- $21,000 ÷ $60,000 = 0.35 = 35%.
Answer: 35%
Rebuild profit from the margin
- New gross profit is new revenue times the new gross margin.
- Subtract the new operating expenses.
worked example
Revenue rises from $20,000 to $25,000. Gross margin falls from 40% to 32%, and operating expenses rise from $4,000 to $5,000. What is the new operating profit?
- New gross profit: $25,000 × 0.32 = $8,000.
- New operating profit: $8,000 − $5,000 = $3,000.
- Before: $20,000 × 0.4 − $4,000 = $4,000.
Answer: $3,000
Weight by revenue
- Turn each margin into profit dollars: revenue times the margin.
- Add the dollars, then divide by total revenue.
worked example
A café sells $30,000 of coffee at a 70% gross margin and $10,000 of food at a 30% gross margin. What is the combined gross margin?
- $30,000 × 0.7 = $21,000. $10,000 × 0.3 = $3,000.
- ($21,000 + $3,000) ÷ $40,000 = 0.6 = 60%.
Answer: 60%
watch out for
- Dividing by costs, or dividing revenue by profit. A margin divides a profit line by revenue.
- Assuming a bigger dollar profit means a better margin. Compare the percents.
- Assuming profit grows at the same rate as sales.
- Averaging two margins without weighting by revenue.
practice
Margin as a % of revenue
worked example
Revenue is $45,000 and net income is $10,125. What is the net margin?
Answer: 22.5%
- Margin = net income ÷ revenue = $10,125 ÷ $45,000 = 0.225 = 22.5%.
Did the margin improve?
worked example
Revenue is $50,000 with $17,500 of gross profit one month, then $60,000 with $19,800 the next. What happened to the gross margin?
- It stayed the same
- You can't tell without the cost lines
- It rose
- It fell
Answer: It fell
- Margin 1 = $17,500 ÷ $50,000 = 35%; margin 2 = $19,800 ÷ $60,000 = 33%.
- More gross-profit dollars can still mean less profit per sales dollar.
Sales up, profit down?
worked example
Revenue rises from $27,000 to $33,750. Gross margin falls from 55% to 51%; operating expenses rise from $6,000 to $7,000. What is the new operating profit? (Use a minus sign for a loss.)
Answer: $10,212.50
- New gross profit = $33,750 × 51% = $17,212.50.
- New operating profit = $17,212.50 − $7,000 = $10,212.50 (it was $14,850 − $6,000 = $8,850).
Combined margin of two parts
worked example
Division A has $22,000 of revenue at a 40% gross margin. Division B has $33,000 at 22%. What is the combined gross margin?
Answer: 29.2%
- Gross profit: A = $22,000 × 40% = $8,800; B = $33,000 × 22% = $7,260.
- Combined = ($8,800 + $7,260) ÷ $55,000 = 29.2%.