Fundamental analysis is used to determine if a company is a good investment. It uses numbers from a company's income and cash-flow statements as well as its balance sheet to calculate ratios. These ratios are then used to determine a company's worth and its potential for growth. How a company ranks among its peers gives the analyst an indication as to whether it is a good investment.
Calculating profit margin is a good way to gauge how well a company handles the money it makes. Profit margin is the percentage of each dollar of sales that the company is able to keep. Profit margin is calculated on three different levels, gross profit margin, operating profit margin and net profit margin.
The financial ratio that is the best measure of a company's operating efficiency is its operating margin. There are certain expenses that are necessary to run a business. These expenses are know as operating expenses. They vary depending on the type of business you are in. Expenses such as raw materials and wages are examples of operating expenses. Operating margin is the percentage of every dollar of sales that a company is left with after operating expenses are deducted.
Calculating Operating Margin
The mathematical formula for calculating profit margin is operating income divided by total revenue equals operating margin. For example, if corporation S has a total revenue of $78 million and an operating income of $27 million, you divide $27 million by $78 million to get 0.346. Operating margin is usually stated as a percent. If you multiply 0.346 by 100 it equals 34.6 percent. Corporation S has an operating margin of 34.6 percent, which means it is able to keep about 35 cents out of every dollar it earns in revenue after operating expenses have been deducted.
Good or Bad
When analyzing profit margin, the higher the number the better. That doesn't mean that a company with a 70 percent profit margin is more efficient than a company with a 40 percent profit margin. Operating margins should always be compared between companies in the same or similar industries. You wouldn't compare the margins of a pizzeria to those of an auto maker. If the margins of one company are much lower than the industry average, it suggests that the company is not being run as efficiently as its peers, which could indicate that money is being wasted.
- "Fundamental Analysis For Dummies"; Matt Krantz; 2009
- Photo Credit Jupiterimages/Photos.com/Getty Images
The Purpose of Financial Ratios
Financial ratios have two primary users, investors and management. Management uses financial ratios to determine how well their firm is performing in...
What Is the Purpose of an SOP?
An introduction to the purpose and uses of a standard operating procedure in business, with examples and steps on how to create...
How to Calculate an Efficiency Ratio
Efficiency ratios measure how effectively a business uses its assets and manages its operations. Asset turnover ratios, activity ratios and asset management...
How to Measure the Effectiveness of a Quality System
Measuring the effectiveness of your company's quality system is an essential part of your overall quality control program. Even if your quality...
How to Choose Best Gear Ratio for Drag Racing
The gear ratio in any gear assembly refers to the ratio of teeth between two connected gears. A gear ratio of 5:1...
How to Use Financial Ratios to Make Managerial Decisions
Managers have many tools at their disposal to help with decision making, and among the key tools used are financial ratios as...
How to Measure the Profitability of a Company
Businesses exist to make a profit. That is, to sell products and/or services to the public at a price higher than what...
What Is the Most Energy-Efficient Clothes Dryer?
Clothes dryers account for around 6 percent of all residential energy consumption, according to the U.S. Environmental Protection Agency. Choosing the most...
Which Financial Ratios Would You Find Most Useful When Investing in a Company?
When investors perform a financial analysis of a company, they examine a number of different financial ratios for insight into the firm's...
What Are Efficient Ways of Handling Corporate Outgoing Mail?
Efficiently handling a corporation's outgoing mail ensures that important information, time-sensitive communications and payments reach their destination on time. It also encourages...