Why Does Revenue Increase When the Gross Profit Margin Decreases?
The same 2008 financial crises that led to businesses hoarding cash has evolved into a financial climate in which cash exists in abundance at many companies. According to a Bain & Company report, just two years after the downturn began, global capital balances grew to $600 trillion in 2010. In 2017, the consulting firm states that global financial capital stands at 10 times gross domestic product, or GDP.
According to Bain, in times such as these, reasonably profitable large enterprises can easily obtain capital to buy new equipment, fund research and development, enter new markets or acquire a new business.
Consequently, it might be time for leaders of average businesses to turn their sights from cash flow to profit margin and focus on ways their companies might work to ensure the latter is on an upward climb.
The relationship between revenue and profit margin is an interesting one. Whereas the amount your company earns through the sale of products and services and other ventures is defined as sales revenue, profit margin is the amount by which sales revenue exceeds the costs of generating that revenue.
For purposes of the profit margin, sales revenue or "gross sales" is unrelated to the expenses incurred to earn that revenue. If a service company, for example, experiences "top-line growth," its gross sales are reaching a new, higher level.
Though used interchangeably, sales and revenue are not the same thing in that a company can have revenue sources other than sales proceeds, such as revenue from investments or an affiliated partner.
On the other hand, profit margin is the amount by which sales revenue exceeds the costs, including taxes and other expenses, that were incurred to generate the sales. Therefore, profit margin gauges the degree to which a firm effectively uses its assets and incurs expenses to generate its sales revenue.
You might own a company that licenses software that can crack a smartphone or a business with a primary endeavor to rid the ocean of plastic. In either case, to remain in operation, your business must earn sales revenue at some point or have access to other sources of capital such as shareholder investments.
As odd as it may seem, it’s less necessary to earn a profit, or have a healthy profit margin, as evidenced by Twitter, Snapchat and Uber. For instance, in the fourth quarter of 2018, Twitter earned $91 million, its first profits in the 12 years since its founding in 2006.
Even so, at some point, investors will expect to earn a return on their investments and the size of that return is determined in part by the relationship between two factors, revenue and margin.
A profitability analysis measures your ability to make a profit. The gross profit margin calculation yields a gross profit represented as a percentage. The calculation requires that you divide gross profit by total revenue. For example, you divide $250,000 gross profit by $750,000 total revenue, which a equals a 33% gross profit margin. For every revenue dollar, a 33-cent gross profit is earned.
The higher the degree that gross profit is greater than total revenue, the more efficient your company is in employing its assets to generate sales. An acceptable gross profit margin varies by industry, so you should compare the figure to that of competitors and industry averages.
A large number of variables contribute to both profit and revenue. It’s possible that, from one reporting period to the next, revenue may increase while the gross profit margin decreases. A profit margin decrease might occur if a company decreases prices to increase sales.
Alternatively, the profit margin decrease might result from cost increases or some combination of cost and price decreases.