Corporations and their shareholders are determined to make profits from their business operations and make a good return on their investment (ROI). In order to make good profits, a firm needs to be run efficiently and have sufficient cash flow to meet current liabilities and short term debt (liquidity). You as a small scale investor need to investigate the profitability of a company in order to determine if it is both liquid and it is being run efficiently. The way to do this is by calculating the various profit margin ratios available. We look at a few below:
i) Gross Profit Margin
The Gross Profit Margin illustrates the profit a company makes after paying off its Cost of Goods sold (cost of inventory). Gross Profit Margin illustrates to us how efficient the management is in using its labour and raw materials in the process of production. The formula for Gross Profit Margin is:
Gross Profit Margin = (Sales - Cost of Goods Sold) / Sales
Firms that have a high gross profit margin are more liquid and thus have more cash flow to spend on research & development expenses, marketing or investing. Avoid investing in firms that have a declining Gross Profit Margin over a time period, example over 5 years. Once you calculate the gross profit margin of a firm, compare it with industry standards. For example, it does not make sense to compare the profit margin of a software company (typically 90%) with that of an airline company (5%).
ii) Operating Profit Margin
The Operating Profit Margin will illustrate to you how efficiently the managers of a firm are using business operations to generate profit. This ratio also shows the success rate of these managers. The formula for Operating Profit Margin is:
Operating Profit Margin = Earnings before Interest & Taxes / Sales
For example, consider a firm that has $2 million sales this year and an EBIT (Earnings before Interest & Taxes) of $450,000. What is the Operating Profit Margin?
Operating Profit Margin = 450,000 / 2,000,000
Operating Profit Margin = 22.5%
The higher the Operating Profit Margin, the better. This is because a higher Operating Profit Margin shows the company can keep its costs under control (successful cost accounting). A higher Operating Profit Margin can also mean sales are increasing faster than costs, and the firm is in a relatively liquid position.
The difference between Gross Profit Margin and Operating Profit Margin is that the gross profit margin accounts for only Cost of Goods sold, but the Operating Profit Margin accounts for both Cost of Goods sold and Administration/Selling expenses.
iii) Net Profit Margin
Net Profit Margin tells you exactly how the managers and operations of a business are performing. Net Profit Margin compares the net income of a firm with total sales achieved. The formula for Net Profit Margin is:
Net Profit Margin = Net Income / Sales
For example, consider a firm that has an annual net income of $500,000 while the total sales achieved during the year amount to $2,200,000. What's the Net Profit Margin?
Net Profit Margin = 500,000 / 2,200,000
Net Profit Margin = 22.7%
Once you calculate the net profit margin of a firm, compare it with industry standards. For example, typical software companies have a Gross Margin of 90% (as mentioned above). However, the NET profit margin is only 27%. That's a huge difference right there and it tells us that the marketing/administration costs of software companies is huge! However, this also tells us that operating costs and cost of goods sold of software companies is relatively low.
Thursday, November 26, 2009
India Mahindra Satyam hit by new charges; outlook uncertain
* Investigators say Satyam fraud may be bigger than revealed
* Analysts say Mahindra Satyam a risky bet until restatement
* Shares plunge as much as 18 pct in two days
BANGALORE, Nov 26 (Reuters) - Mahindra-Satyam (SATY.BO) shares fell to a 4-month low on Thursday, before recovering, on concerns over its outlook after Indian investigators filed new charges over accounting fraud that hit Satyam earlier this year.
"Investors are playing a blind game until the audited numbers are out. There could be more skeletons hidden in the closet," said HDFC Securities' head of private client group V.K. Sharma, who is advising clients to stay away from the stock until there is further clarity.
The stock topped the volume chart, with about 30 million shares traded, nearly three times its average daily volume over the past 90 days. It ended up 2.4 percent at 92.75 rupees.
Mahindra Satyam, earlier known as Satyam Computer Services, was acquired by Tech Mahindra (TEML.BO) in April after the company was hammered by India's biggest corporate fraud, which came to light in January. [ID:nBOM476146]
V. V. Lakshmi Narayana, deputy inspector general of India's Central Bureau of Investigation, told Reuters the extent of the fraud at Satyam could be much larger than the 71.36 billion rupees ($1.5 billion) that founder Ramalinga Raju had confessed to in a letter in January.
"All investigations into the accounting and auditing part of the business have been completed, and we are now going to look into the money diversion from the company," Narayana, who is part of the team probing the fraud, said from Hyderabad.
"Whatever Raju said is not the complete reality."
Narayana said the agency estimated losses suffered by investors in the wake of the fraud could be up to 140 billion rupees.
Mahindra Satyam, which has about 35,000 employees, hoped to restate its accounts by the middle of next year, Atul Kunwar, president of its global operations, said on Wednesday.
Vaibhav Sanghavi, director of Ambit Capital, said, "It's very difficult to assess the situation until the audited numbers are out."
Officials at Mahindra Satyam did not respond to requests by Reuters for comment. A Tech Mahindra spokesman declined comment.
Shares in Tech Mahindra (TEML.BO), a unit of tractor and utility vehicles maker Mahindra & Mahindra (MAHM.BO), ended down 1.2 percent, having earlier fallen as much as 6.5 percent to a 3-month low.
Kunwar also told the Reuters India Investment Summit on Wednesday that customer attrition had stopped and the company did not need price cuts to win new deals. [ID:nBNG159632]
On Tuesday, the CBI said it had filed a supplementary charge sheet containing new allegations against Raju and nine others associated with the outsourcing firm. [ID:nBOM490232]
New charges included that revenues had been inflated by 4.3 billion rupees by creating fake invoices and customers, and that forged board resolutions were used to get loans worth 12.2 billion rupees.
On Thursday, Bharat Kumar, a lawyer for Raju, told Reuters he could not comment as he had not received a copy of the additional charge sheet the investigating agency had submitted to the court.
* Analysts say Mahindra Satyam a risky bet until restatement
* Shares plunge as much as 18 pct in two days
BANGALORE, Nov 26 (Reuters) - Mahindra-Satyam (SATY.BO) shares fell to a 4-month low on Thursday, before recovering, on concerns over its outlook after Indian investigators filed new charges over accounting fraud that hit Satyam earlier this year.
"Investors are playing a blind game until the audited numbers are out. There could be more skeletons hidden in the closet," said HDFC Securities' head of private client group V.K. Sharma, who is advising clients to stay away from the stock until there is further clarity.
The stock topped the volume chart, with about 30 million shares traded, nearly three times its average daily volume over the past 90 days. It ended up 2.4 percent at 92.75 rupees.
Mahindra Satyam, earlier known as Satyam Computer Services, was acquired by Tech Mahindra (TEML.BO) in April after the company was hammered by India's biggest corporate fraud, which came to light in January. [ID:nBOM476146]
V. V. Lakshmi Narayana, deputy inspector general of India's Central Bureau of Investigation, told Reuters the extent of the fraud at Satyam could be much larger than the 71.36 billion rupees ($1.5 billion) that founder Ramalinga Raju had confessed to in a letter in January.
"All investigations into the accounting and auditing part of the business have been completed, and we are now going to look into the money diversion from the company," Narayana, who is part of the team probing the fraud, said from Hyderabad.
"Whatever Raju said is not the complete reality."
Narayana said the agency estimated losses suffered by investors in the wake of the fraud could be up to 140 billion rupees.
Mahindra Satyam, which has about 35,000 employees, hoped to restate its accounts by the middle of next year, Atul Kunwar, president of its global operations, said on Wednesday.
Vaibhav Sanghavi, director of Ambit Capital, said, "It's very difficult to assess the situation until the audited numbers are out."
Officials at Mahindra Satyam did not respond to requests by Reuters for comment. A Tech Mahindra spokesman declined comment.
Shares in Tech Mahindra (TEML.BO), a unit of tractor and utility vehicles maker Mahindra & Mahindra (MAHM.BO), ended down 1.2 percent, having earlier fallen as much as 6.5 percent to a 3-month low.
Kunwar also told the Reuters India Investment Summit on Wednesday that customer attrition had stopped and the company did not need price cuts to win new deals. [ID:nBNG159632]
On Tuesday, the CBI said it had filed a supplementary charge sheet containing new allegations against Raju and nine others associated with the outsourcing firm. [ID:nBOM490232]
New charges included that revenues had been inflated by 4.3 billion rupees by creating fake invoices and customers, and that forged board resolutions were used to get loans worth 12.2 billion rupees.
On Thursday, Bharat Kumar, a lawyer for Raju, told Reuters he could not comment as he had not received a copy of the additional charge sheet the investigating agency had submitted to the court.
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