Lesson 6 of 7 · 15 min
Operating profitability and working capital
Margins built from functional cost lines (gross, EBITDA, EBIT), costs expressed as a percentage of revenue, and working capital measures (cash conversion cycle, net working capital to sales) show how efficiently a company turns revenue into profit and cash.
In short
- Most issuers present costs by function, giving three profitability measures: gross profit, EBITDA and operating profit (EBIT), each also as a margin on revenue.
- Cost of sales is mostly variable, so gross margin ≈ contribution margin. SG&A, R&D and D&A are largely fixed (with exceptions such as commissions).
- Over the long run output drives costs, even fixed ones, so analysts express costs as a % of revenue and look for economies of scale (lower unit costs with size) and economies of scope (shared costs across product lines).
- Industry profitability is set by competition, so do not judge margins company by company in isolation.
- Working capital: a short cash conversion cycle means less external financing; negative net working capital means suppliers finance the company.
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