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Analysing a firm’s sales and operating profits

india Updated: Aug 03, 2008 23:34 IST
Arnav Pandya
Arnav Pandya
Hindustan Times
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A company’s performance during a quarter is often used by investors to determine whether putting their money into it would result in a sound investment. Hence it is imperative to understand the trends and their implications for a company to come to the right decision. One such factor that should be taken into account is when a company has rising sales but its operating margins are under pressure.

Inflation impact

On one hand the trend of witnessing a rise in the sales of the company is a good sign because a higher top line, as it is called, will provide a larger opportunity for the company to make a profit, which in turn will expand as the sales rise. At the same time knowing the reason for the rise in the sales is very important. This can occur on account of two factors. One could be a rise in the product’s pricing due to inflation contributing to higher sales. If this is the case then the profit margin of the company becomes very important. The other reason could be that the company is selling a larger quantity of the product and this can be a very good sign going forward.

Operating profit

There are various kinds of profits that are shown in a company’s financial statement. Many people prefer to look at just the net profit which is the final profit earned by the company. There is another important profit figure known as the operating profit that often gives a better picture of the company’s performance. This is the profit that is earned after excluding all non operating items like interest, depreciation and taxes and hence shows how much profit is earned by items that go into the normal operations of the company.

Pressure on operating margin

The operating profit divided by the net sales and multiplied by 100 gives the operating profit margin. If there is pressure here, it shows that various input costs and other operating costs like fuel or power or even salaries is reducing the profit per sale. This has to be maintained at a certain level but if it falls sharply then there can be problem as far as the valuation of the company is concerned. Thus it is vital that this factor be considered along with other items like sales because then it will give a complete picture of the company’s performance to the investor.