[lbo-talk] corporate profits?

[Gar Lipow]

On Thu, Dec 17, 2009 at 2:51 PM, Mike Beggs <mikejbeggs at gmail.com> wrote:
> On Fri, Dec 18, 2009 at 9:07 AM, shag carpet bomb <shag at cleandraws.com> wrote:
>> if a company earns 900 million in revenue with 90 million or so profit, the
>> rest expenses and taxes, what is that called?
>>
>> poking around, i get the impression it's not called a profit rate or a
>> profit margin. could be misunderstanding, though.
>>
>> and in any event, i seem to recall doug posting something here indicating
>> that the typical large, public corporation had about 1-2% profits --
>> whatever that meant, actually. Is that correct?
>
> To get a profit rate you need something for the denominator - not the
> revenue but the amount invested. Which can be defined in a number of
> ways. The simplest accounting definition is the rate of return on
> equity - basically you divide the profit figure by the book value of
> the company's assets minus liabilities other than equity.
> Theoretically, the profit rate is the value of profit over some time
> period divided by the value tied up in generating it. 'Tied up' is
> pretty vague, which you could define in different ways depending on
> what you are using it for, or what information is available. But you
> use 'tied up' rather than 'cost' because certain elements of cost
> circulate faster than others - e.g., if the company pays wages every
> week and gets back the same funds every week as part of revenue, on an
> annual basis only the weekly cost of wages is 'tied up', the same
> funds cycling in and out through the books week by week. For that
> reason theoretical treatments of the profit rate often just use the
> value of fixed capital (machinery etc) as the denominator.
>
> Cheers,
> Mike
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> http://mailman.lbo-talk.org/mailman/listinfo/lbo-talk
>

Hi Mike. What you describe is return on investment. Gross Profit Rate
is actually very close to to what Shag is describing. (Revenue - Cost
of Goods Sold)/Revenue.  Because the Gross Profit Rate is not used
consistently it sometimes excludes fixed expenses. (When it includes
fixed expenses [and it can], then it is exactly the number Shag
described).

 However it is very important to distinguish this from return on
investment, which I think was the point you were making. For example,
in the days when supermarkets were fat and happy and making tons of
money, it was common for them to have a Gross Profit Rate or Gross
Margin of as little as half a percent. It is so long since I had deal
with retail programming that I forget how often supermarkets turn over
their inventory, for the sake of an example say every two weeks (it is
not too far from that anyway). That would result in around a 13%
return on investment (.5% on the same capital 26 times per year). So
when a retailer bitches about how tight their gross margin is they may
be telling the truth and yet making a huge profit because of high
turnover.  The opposite can happen too.If you sell electron
microscopes with a 21% gross margin, but it takes you three years to
move one, your return on investment is 7% per year.

Gross profit margins are mainly used for comparing companies in the
same industry. Like any single indicator it can be misleading, but
other things being equal, there are standard profit margin figures
published for most industries, and so you can look at a particular
corporate gross margin and use it as one indication to see if that
corporation is in better or worse shape than industry average and in
better or worse shape than a competitor.