Chapter 9
FINANCIAL ANALYSIS : Margin analysis: Structure

The first step in any financial analysis is to analyse a company's margins. This is absolutely vital because a company that fails to sell its products or services to its customers above their cost is doomed.

An analysis of margins and their level relative to those of a company's competitors reveals a good deal about the strength of a company's strategic position in its sector.

Operating profit, which reflects the profits generated by the operating cycle, is a central figure in income statement analysis. First of all, we look at how the figure is formed based on the following factors:

Further down the income statement, operating profit is allocated as follows:

Diverging trends in revenues and charges produce a scissors effect, which may be attributable to changes in the market in which the company operates, e.g. economic rents, monopolies, regulatory changes, pre-emptive action, inertia. Identifying the cause of the scissors effect provides valuable insight into the economic forces at work and the strength of the company's strategic position in its sector. We are able to understand why the company generates a profit, and get clues about its future prospects.