'Margin' is explained in detail and with examples in the Corporate Finance edition of the Herold Financial Dictionary, which you can get from Amazon in Ebook or Paperback edition.
Margin refers to a term used by companies and corporations in business. It is the spread between the firm’s product or service sales price and the cost to make it. Another way of putting this is the ratio of firm’s revenue to expenses. Margin can be utilized to refer to profit margins, operating margins, net margins, pretax profit margins, and gross profit margins.
Profit margin is the larger catch all category for many of these margins. Analysts and businesses figure it as the total net income divided by the firm’s revenues. Another way of deriving it is through net profits divided by sales. Coming up with the net income is not hard. It requires that individuals subtract out the total of a firm’s given expenses. This means that all material costs, operating costs, interest expenses, and taxes costs will have to be deducted from the total revenue. Such profit margins become expressed in percentage terms. In practice they measure the amount from each dollar in sales that the corporation gets to keep as earnings.
The other business margins are not difficult to understand and are simply variations on profit margins. With gross profit margins, the phrase displays the connection between firms’ total sales revenues and their COGS cost of goods sold. Conversely, operating profit margins consider the cost of goods sold along with the operating expenses. They compare these against the revenues. Finally, net profit margins gather all of these expenses, interest paid on loans and bonds, and taxes to compare them to total sales revenues.
It is always useful to look at practical examples to better understand complex concepts. Consider a company like Burger King. They might claim an 18 percent profit margin. This would mean that after they paid their expenses, labor costs, material costs, any interest on debt, and taxes, they would have left 18 cents on every dollar of sales revenues they realized.
Margin can have several other meanings as well.
A common one has to do with investor accounts. Many stock or options’ account holders will have what industry personnel call a margin account. This permits the investors to be able to purchase their securities on margin. They may buy a stock or option by only having to pay a certain set and predetermined percentage of the cost of the investment. The remaining cost they simply borrow from the brokerage firm or the associated bank of the firm.
In most cases, the broker becomes the lender and carries out these functions as expected. This means that they enforce the collateral requirement and minimum maintenance requirements. The securities which the investor purchased using the margin account become the collateral for the balance of the loan. This will commonly be expressed using a percentage.
Consider an example of this to better understand the idea. Investors may purchase $10,000 in stocks with margin. As the rate is set by the brokerage firm at 25 percent, they will have to deposit and pay $2,500 of their own cash. The remainder $7,500 they simply borrow from the brokerage company (or bank). This makes great sense for those investors who predict that the return they will realize on the investments will significantly outweigh the cost of the loans.
Margins are also utilized as a concept with regards to mortgages. Some particular mortgages are called ARMs, or adjustable rate mortgages. They provide a fixed interest rate during some type of introductory time frame. At that point, the rate adjusts up (sometimes dramatically). Banks figure up this new rate by simply adding margins on to the pre-established index. Such margins typically remain fixed during the remainder of the loan’s life span. Yet the rate of the index can and will change.