What is margin?
Margin has multiple meanings. In business, margin is the profit generated after accounting for costs, which is expressed as a percentage. In investing, margin is the deposit an investor places with a broker when borrowing money to buy a security. In lending, margin is the difference between the amount of money borrowed and the value of the collateral that secures the loan.
In business, margin is calculated in three ways:
- Gross profit margin is the profit made after deducting the costs of the goods sold. It doesn’t account for other costs like operating expenses and taxes.
- Operating profit margin measures profit after factoring overhead costs, including labor and administrative costs.
- Net profit margin measures profit after subtracting taxes, interest expense and overhead. Higher profit margins are considered better as they represent the company’s ability to effectively control costs.
If an investor borrows on margin, he makes a deposit with the broker who loans the money. Under the Federal Reserve Board’s Regulation T, investors may borrow up to 50 percent of the purchase price of a security purchased on margin. If the security price drops, the broker issues a margin call, which requires the investor to add additional money to the deposit. Investors borrow on margin to increase their profits by increasing the amount invested in the security. Borrowing on margin can also result in greater losses.
In lending, different loans require different margin levels. Higher margins are more secure and increase the lender’s ability to recover his costs if the loan cannot be repaid.
Suppose a jewelry store buys a ring for $2,000 and sells it for $3,000. The store’s gross profit margin is 50 percent. If the overhead costs are $400, the operating profit margin is 20 percent. If the taxes are $300 the net profit margin is 10 percent.
Say Ann wants to invest $1,000 in stock. She funds half of it with money loaned by the broker and half with money in her brokerage account. If the stock’s share price increases by 20 percent when Ann sells her shares, she will profit $200 and increase her profit 100 percent by investing on margin. If the stock price drops 20 percent instead, the investment will be worth $800, and she will lose 100 percent more money by investing on margin.
Need to work out the profit margin of your business? Use Bankrate’s gross profit margin calculator.