Gross Margin and Operating Margin explained

[@TheFinanceStoryteller]

Enjoyed the video? Then subscribe to the channel right now, and let's dive into large specific areas of the income statement: COGS (Cost Of Goods Sold) kzbin.info/www/bejne/oHa4n3ablJ58Y9U and SG&A (selling, general and administrative expenses): kzbin.info/www/bejne/a4ScqZ14jd1orJI

[@ricktandron3669]

Great examples. Thanks for sharing.

[@TheFinanceStoryteller]

Glad you enjoyed it, Rick! Soon the 2020 full year numbers for these companies will be available. It will be exciting to see how the margins have developed.

[@jeqnluc]

Great video. I was wondering why specificly gross margin most of the time gets mentioned as the best indicator of pricing power and not operating margin. Can you explain that?

[@TheFinanceStoryteller]

Gross Margin is an excellent metric for review and discussion of product or service profitability. You zoom in on what you sell it for (revenue) versus what you make it for (cost of goods sold, or in the case of services called cost of revenue). The difference between the Gross Margin and the Operating Margin lines in the income statement consists mostly of SG&A (selling, general and administrative expenses) and R&D (research and development) costs, these are sometimes referred to as fixed costs or base costs and not immediately relevant to analyze product margin. See also my videos on SG&A kzbin.info/www/bejne/a4ScqZ14jd1orJI and the example of analyzing an income statement kzbin.info/www/bejne/fqKQZWeGfcx0n7c and Cost of Goods Sold kzbin.info/www/bejne/oHa4n3ablJ58Y9U

[@rvteja50]

this explanation took me back to my B School. Very simple and best way to explain!

[@TheFinanceStoryteller]

Thank you, Ravi! Wonderful to hear that. :-)

[@BusinessBestie]

I love this guy. Thanks for making it easy to understand. Short and to the point

[@TheFinanceStoryteller]

Love you too, Dana! :-) Thank you for watching and commenting.

[@TheFinanceStoryteller]

I have recently made some follow-up videos that relate to Gross Margin and Operating Margin, that could be helpful for you as well: Cost of Goods Sold kzbin.info/www/bejne/oHa4n3ablJ58Y9U and a case study walking through the various sections of Microsoft's income statement kzbin.info/www/bejne/fqKQZWeGfcx0n7c

[@cloudsurf5460]

Awesome explanation, thank you so much! However, the income statement I have here has "Other Operating Income" and then "Operating Results" and I'm trying to calculate operating margin using net sales and operating income. Which one of these figures must I use? I really need help.. Thanks in advance!

[@TheFinanceStoryteller]

If you can e-mail me a screenprint (or tell me which company and year you are looking at), I will try to help.

[@forheuristiclifeksh7836]

1:23

[@ibrahimsalahudin9003]

you are amazing man keep going

[@TheFinanceStoryteller]

Thank you very much, Ibrahim! Please tell your colleagues and friends about the channel. :-)

[@roofvis]

As a finishing touch, God created the Dutch!

[@jorgeyanez2142]

Is cost of goods sold also part of Operating Margin? or just SG/A and RD?

[@TheFinanceStoryteller]

Yes, Cost Of Goods Sold (COGS) is also part of Operating Margin. COGS is an expense that is deducted to get to Gross Margin (and subsequently to Operating Margin). SG&A and R&D are expenses that get deducted "after" Gross Margin to get to Operating Margin. In short: Revenue minus COGS is Gross Margin; and then Gross Margin minus SG&A and R&D is Operating Margin.

[@pianoover50]

Great videos thank you, I am currently studying bookkeeping and they have been most helpful

[@TheFinanceStoryteller]

Great to hear that! Let me know if there are any other topics that you think I should cover in an upcoming video.

[@abdolzamil9061]

if a company has Gross margin more than its Operating margin does it make it better for in investment ?

[@TheFinanceStoryteller]

As you can see from the examples in the video, Gross Margin is by definition higher than Operating Margin. The difference between them is SG&A (selling, general and administrative) expenses and R&D (research and development) expenses. Have a look at the video I recently made on the income statement of Apple, and you will see how that works: kzbin.info/www/bejne/faLIe6Sibap2etU

[@tE00844]

I think some of the calculations are either off or I'm missing something.

[@TheFinanceStoryteller]

If you provide me specific examples of calculations that you think are incorrect, and why, then I will gladly check them.

[@jadetassi2140]

Loved the explanation. Thank you so much!

[@TheFinanceStoryteller]

You're very welcome! Here's the link to the sequel: kzbin.info/www/bejne/fpzRpqh4oNyMnck

[@sureshkv8135]

Great video! Clarifies this perfectly well, especially like the use of well known company examples

[@TheFinanceStoryteller]

Thank you, Suresh! I enourage you to look up some other companies of your choice as well, or the latest numbers for the companies in this video (e.g. on Amazon it's fascinating to see what the contribution of AWS to the total is).

[@jersonvega9872]

As simple as it should be :) Nice explanation.

[@TheFinanceStoryteller]

Thank you very much! Happy to hear that. Please spread the word! :-)

[@myhappyskin3093]

Not sure, but are you not mixing up gross profit/ operation profit with gross/operation margin. You call both the same? Otherwise, great video! Thank you!

[@TheFinanceStoryteller]

Thanks for the kind words! To add a bit of context: I am used to working in/with companies that just call it Gross Margin $ / Gross Margin % and Operating Margin $ / Operating Margin %. I know that other companies might use one term for the absolute $, and the other one for the %.

[@urbi11]

@@TheFinanceStoryteller Hallo! I'm a big fan of your channel, thanks for the great videos! Sorry, just a question: when talking about Adobe you say that incremental revenue results because of operating leverage to high operating margin. Shouldn't it be instead of margin "operating expenses"?

[@sijotjos]

You well explained with best examples.

[@TheFinanceStoryteller]

Thank you very much, Sijo Jose!

[@kirankk8473]

Nice Video, but I think you are referring Profit/Earning/Income instead of Margin. To get margins on Top of this you have to divide them with Revenues

[@TheFinanceStoryteller]

I think that's what I did, as evidenced by the calculations by company in the second half of the video.

[@shanhongyue353]

Excuse me , at 7:00mins U gave us an example about apple .when it comes to operating margin The total operating expense is 24....but when u calculated the operating margin u use the expense plus the total expense then divide the revenue so I guess this is a mistake ,right? Pls answer me I am so confused

[@TheFinanceStoryteller]

Hello Shan! Gross Margin = Sales minus Cost of Sales = $215.6B - $131.3B = $84.3B Operating Income = Gross Margin minus Operating Expenses = $84.3B - $24.3B = $60B You could get to the same answer by taking Operating Margin = Sales minus Cost of Sales minus Operating Expenses = $215.6B - $131.3B - $24.3B = $60B Maybe you got confused by Apple using the term Operating Expenses as only the sum of R&D and SG&A expenses? In other words, Operating Expenses does not include the Cost of Sales.

[@HusseinDoha]

At (5:29), where the heck did the $1.5B in variable cost came from? It should be close to $2B (if you include R&D and marketing)!!!

[@TheFinanceStoryteller]

I am not sure I understand your question. The cost of revenue ("variable cost") was $820 million in 2016. Research and development, sales and marketing, general and administrative, are all "Operating Expenses" or "fixed costs".

[@EnkhturDamdinjav]

where do depreciation expenses go into?

[@TheFinanceStoryteller]

That depends on the "format" that a company chooses for its P&L. In the functional format (with COGS, SG&A, R&D), the depreciation for manufacturing equipment goes into COGS, the depreciation for office equipment to SG&A, the depreciation for lab equipment to R&D. In the variable cost - fixed cost format, depreciation goes into fixed cost. There the formula is revenue minus variable costs equals contribution margin, while contribution margin minus fixed costs equals operating margin.

[@EnkhturDamdinjav]

@@TheFinanceStoryteller Thank you for this detailed and easily understandable response, it's being appreciated very much.

[@TheFinanceStoryteller]

You're welcome! Happy to help. 🙂

[@vikashbarnwal4840]

please teach ratio analysis ..

[@TheFinanceStoryteller]

Hello Vikash! Here's the link to my video on financial ratio analysis kzbin.info/www/bejne/g4XUaHurq9R6mc0 and here's the link to my video on DuPont ROE analysis kzbin.info/www/bejne/mJnFdXeJpM19bpY Enjoy! Let me know what you think!

[@BossChronicles]

👍 keep up these videos

[@TheFinanceStoryteller]

Thanks! Many more coming over the next few months.

[@dolevmazker736]

nice video, my intuition said adobe :)

[@TheFinanceStoryteller]

Yeah, I love that quiz!!! So insightful how margin percentages vary by industry/company. Next question: can you guess what the Gross Margin and Operating Margin rates are for Microsoft? Answer in my video explaining the income statement: kzbin.info/www/bejne/fqKQZWeGfcx0n7c

[@dolevmazker736]

@@TheFinanceStoryteller Thanks i just did that. went to Microsoft investor relation, then opened up the 2019 financial statement. went to selected financial data, and pulled up the percentage by the formula. Here is what i got 1. Operating margin - 34% 2. Gross margin - 66%

[@TheFinanceStoryteller]

I got to the same percentages! Amazing how different those are from the Apple margins, right?

[@dolevmazker736]

@@TheFinanceStoryteller ill check that out right now

[@dolevmazker736]

So i checked that the changes on net income for Apple is 21%, while microsoft is 31% (net income). I checked the previous years on both companies and perhaps the apple net income, and revenue was steady and dashing up and down, it might show that apple is starting to lose its competitive advantage even tho the brand is unique. Where you look at microsoft's net income change in the previous years was low and a sudden jump of the net income might actually show good signs of technological advantage as the revenue isnt as big as apple but it is increasing in the years to come. This is just a rough idea of what i could come up with 15 minutes of just looking at the two companies balance sheet. I would look to further details to see why microsoft had such a big positive change on revenue😄

[@Fw8888]

What is -/-????

[@TheFinanceStoryteller]

A finance guy's way of saying minus. ;-)