Corporate Finance, 4th Edition

Chapter 9Margin analysis: structure

If financial analysis were a puppet, company strategy would be pulling its strings

An analysis of a company's margins is the first step in any financial analysis. It is a key stage because a company that does not manage to sell its products or services for more than the corresponding production costs is clearly doomed to fail. But, as we shall see, positive margins are not sufficient on their own to create value or to escape bankruptcy.

Net income is what is left after all the revenues and charges shown on the income statement have been taken into account. Readers will not therefore be very surprised to learn that we will not spend too much time on analysing net income as such. A company's performance depends primarily on its operating performance, which explains why recurring operating profit (or EBIT) is the focus of analysts' attention. Financial and non-recurrent items are regarded as being almost “inevitable” or “automatic” and are thus less interesting, particularly when it comes to forecasting a company's future prospects.

The first step in margin analysis is to examine the accounting practices used by the company to draw up its income statement. We dealt with this subject in Chapter 8 and shall not restate it here, except to stress how important it is. Given the emphasis placed by analysts on studying operating profit, there is a big temptation for companies to present an attractive recurring operating profit by transferring operating ...