Understanding Profit Margins

For best results when evaluating, investing in and following stocks, you should know your way around the income statement (sometimes called the statement of operations), which summarizes sales and profits over a period of time, such as three months or a year.

Consider McDonald’s income statement for 2017. At the top, you’ll find net revenue (sometimes called sales). For McDonald’s, it’s $22.8 billion. As you work your way down the income statement, various costs will be subtracted from revenue, leaving different levels of profit. The item you’ll find just under revenue is “cost of goods sold” (sometimes abbreviated as COGS or called cost of revenue), representing the cost of producing products or services sold. For McDonald’s, it’s $12.2 billion. Subtract the COGS from revenues, and you’ll get a gross profit of $10.6 billion.

To find the gross margin, which reflects the costs of production relative to revenue, simply divide the gross profit by revenue. Dividing $10.6 billion by $22.8 billion yields a gross margin of 0.46, or 46 percent. It’s often illuminating to compare the results with peers. For example, gross margin is 58 percent for Wendy’s and 60 percent at Starbucks.

Next, the remaining costs involved in operating the business, such as support staff salaries, utility bills and advertising expenses, are subtracted, leaving the operating profit. McDonald’s operating profit is $9.6 billion. Dividing this by revenue yields an operating margin of about 42 percent. Crunching older numbers reveals that McDonald’s operating margin is up from 28 percent two years earlier, reflecting great improvement. (Both Wendy’s and Starbucks sport operating margins of 18 percent.)

Finally, after items such as taxes and interest payments are accounted for, we arrive at net income, near the bottom of the statement. McDonald’s is $5.2 billion. Dividing that by revenue yields a hefty net profit margin of 23 percent. This number reflects how many pennies from every dollar of sales McDonald’s keeps as profit. (Wendy’s net margin is 16 percent, and Starbucks’s is 13 percent.) When it comes to profit margins, McDonald’s is strong.