Solve Profit margin issue with margin ratio?

Question

As Profit margin is reducing, could we look at it through margin ratios (like Income statement analysis)

- Reduction in Gross margin indicates following possibility (1) price/unit reduction, (2) increasing in cost/unit ,(3) change in product mix that increase % of low gross margin product.

- If not because of the Gross margin,operating marign decreases, the problem could be an increase in % of SG&A : (1) SG&A increase in absolute , (2) gross profit decreases.

- If not all of above reasons, could be increase in % of cost interest.

Does this make sense?

Thank you.

Answer 1

Hello Tuan,

Your analysis seems perfect, at least for a first approach to the problem. Be sure that you don't consider just the production cost/unit but also overall costs like delivery. For example, a less efficient order management could result into shipment at half of the capacity.
To tackle this, the most effective strategy is to consider always the €/unit ration per each cost.

Best,
Luca

Answer 2

Hi Tuan,

I think it totally makes sense to look at this in terms of the P&L (in fact, that's exactly how I would recommend to think about most of the profitability cases). We don't know whether by "Profit" they mean Net earnings, Operating profit or Gross profit, so that might be something that you want to clarify in the beginning of the case to simplify the analysis (still I'd suggest to speak out your logic before asking).

A couple of minor comments:

- To your second point if it's not the gross margin, but the % of SG&A - (1) agree, (2) we can even simplify as "revenue decreases" (<=> gross profit decrease & gross margin stays the same). Also, can it be a change in D&A?

- To your third point, does it make sense to add Taxes as well?

Hope this helps!

Best regards,

Vasily