When we talk about business, it is important to understand the concept of financial margins. These are key indicators that allow us to evaluate the profitability of our venture. Knowing the margins of our business helps us determine if the difference between the income obtained from the sale of products or services and the costs associated with their production and operation is favorable.
In other words, financial margins allow us to determine whether we are generating enough profit after deducting all the costs involved in the production and operation of our business. This is crucial for assessing the company’s financial health and making strategic decisions aimed at improving profitability and operational efficiency.
What are the types of financial margins?
There are different types of margins, these are gross margin and net margin. Let us look at them in more detail:
Gross Margin
According to the Glossary of the SBS (Superintendency of Banking, Insurance and Private Pension Fund Administrators of Peru), the gross margin is the difference between the total revenue generated by the sale of products or services and the direct cost associated with the production of those products or services. It is a key indicator of the profitability of the operations of a business, as it shows how much money is left over after deducting direct production costs.
Let us present an example
Imagine that a Peruvian company sells handicrafts and generates a total income of 20,000 soles in one month. The direct production costs of the handicrafts, including materials and direct labor, add up to 12,000 soles in that same month.
This means that the company has a gross margin of 8,000 soles. That is to say, after covering the direct costs of production, the company generates 8,000 soles available to cover other operating expenses and generate net profits.
Net Margin
The net margin is a financial indicator that shows the net profitability of a business after deducting all operating expenses. These expenses include direct production costs, as well as overhead expenses, such as rent, wages, marketing, taxes, and other administrative costs.
An example of net margin
If the production costs of the handicraft workshop are 12,000 soles and the other operating expenses add up to 4,000 soles, then the net profits would be calculated as follows.
To calculate net profit: Net profit = Total revenue – Production costs – Other operating expenses
Therefore, the net profits of the handicraft workshop would be 4,000 soles. This means that after deducting all production and operating costs, the business would have 4,000 soles available as net profit. This net margin is crucial for evaluating the final profitability of the business after all the expenses necessary for its operation.
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