Goals of Financial Management
Goals of Financial Management
Maximize Profits A company's most important goal is to make money and keep it. Profit-margin ratios are one way to measure how much money a company squeezes from its total revenue or total sales.
There are three key profit-margin ratios: gross profit margin, operating profit margin and net profit margin.
1. Gross Profit Margin
The gross profit margin tells us the profit a company makes on its cost of sales or cost of goods sold. In other words, it indicates how efficiently management uses labor and supplies in the production process.
Gross Profit Margin = (Sales - Cost of Goods Sold)/Sales
Suppose that a company has $1 million in sales and the cost of its labor and materials amounts to $600,000. Its gross margin rate would be 40% ($1 million - $600,000/$1 million).
The gross profit margin is used to analyze how efficiently a company is using its raw materials, labor and manufacturing-related fixed assets to generate profits. A higher margin percentage is a favorable profit indicator.
Gross profit margins can vary drastically from business to business and from industry to industry. For instance, the airline industry has a gross margin of about 5%, while the software industry has a gross margin of about 90%.
2. Operating Profit Margin by comparing earnings before interest and taxes (EBIT) to sales, operating profit margins show how successful a company's management has been at generating income from the operation of the business:
Operating Profit Margin = EBIT/Sales
If EBIT amounted to $200,000 and sales equaled $1 million, the operating profit margin would be 20%.
This ratio is a rough measure of the operating leverage a company can achieve in the conduct of the operational part of its business. It indicates how much EBIT is generated per dollar of sales. High operating profits can mean the company has effective control of costs, or that sales are increasing faster than operating costs. Positive and
Maximize Profits A company's most important goal is to make money and keep it. Profit-margin ratios are one way to measure how much money a company squeezes from its total revenue or total sales.
There are three key profit-margin ratios: gross profit margin, operating profit margin and net profit margin.
1. Gross Profit Margin
The gross profit margin tells us the profit a company makes on its cost of sales or cost of goods sold. In other words, it indicates how efficiently management uses labor and supplies in the production process.
Gross Profit Margin = (Sales - Cost of Goods Sold)/Sales
Suppose that a company has $1 million in sales and the cost of its labor and materials amounts to $600,000. Its gross margin rate would be 40% ($1 million - $600,000/$1 million).
The gross profit margin is used to analyze how efficiently a company is using its raw materials, labor and manufacturing-related fixed assets to generate profits. A higher margin percentage is a favorable profit indicator.
Gross profit margins can vary drastically from business to business and from industry to industry. For instance, the airline industry has a gross margin of about 5%, while the software industry has a gross margin of about 90%.
2. Operating Profit Margin by comparing earnings before interest and taxes (EBIT) to sales, operating profit margins show how successful a company's management has been at generating income from the operation of the business:
Operating Profit Margin = EBIT/Sales
If EBIT amounted to $200,000 and sales equaled $1 million, the operating profit margin would be 20%.
This ratio is a rough measure of the operating leverage a company can achieve in the conduct of the operational part of its business. It indicates how much EBIT is generated per dollar of sales. High operating profits can mean the company has effective control of costs, or that sales are increasing faster than operating costs. Positive and