Margin pressure is a term used to describe the negative impact of internal or external issues on the profit margins of a business. The analysis of any margin pressure being faced by a business needs to concentrate on three different types of margin:
Analysing the margin pressure a business is coping with will reveal the profit derived from unit sales when compared to total revenue at different points on any income statement. The value of each unit of sales can be affected by costs including net costs, direct costs and operating costs, but in simple terms, anything that drives costs up or revenues down can be described as a form of margin pressure.
Margin pressure will drive the margin lower for any of the three types of profit listed above and this, in turn, will dent overall profit levels.
Margin pressure in finance terms
As far as the finances of any business are concerned, the margin pressure will be a gauge of the profitability of units of sales after costs have been factored in. A margin calculation of this kind is made using a relatively simple formula:
The unit of sales - particular costs / by total revenue.
Calculating margins in this manner, as well as highlighting the presence of margin pressure at different points in the accounting chain, helps to clarify the degree of profitability when compared to total revenue. Margin pressure is a measure of any negative impact on margin ratios and a precursor of unit profitability dropping.
The risk of margin pressure
Margin pressure is a risk to profit levels that businesses aim to either avoid or mitigate. In some cases the margin pressure in question arises as the result of macroeconomic events in the wider operating landscape, such as an increase in costs driven by an uptick in inflation or the introduction of new and oppressive regulations. On other occasions the margin pressure in question might be confined to a single business, being driven by factors such as staffing shortages, a supply chain disruption or production problems.
Recognising the impact of margin pressure
Your business will be able to identify the signs of margin pressure every time price competition shifts or the cost of production rises. Both of these key metrics will be controlled by supply and demand within your given market, with shifts such as the introduction of new tariffs or the arrival in the marketplace of digital disrupters likely to, in this case, drive costs higher and see sales prices being pushed lower respectively.
Businesses seek to spot margin pressure before it has too negative an impact by analysing the profit margins outlined above.
Gross margin = Gross profit divided by revenue. Margin pressure on the gross margin would indicate an increase in direct costs or a drop in the sales price per unit.
Operating margin = Operating profit divided by revenue, and gives a measure of profit derived after direct and indirect costs have been accounted for. Margin pressure here is likely to come from a rise in costs such as those related to admin, selling or labour costs.
Net margin = Net profit divided by revenues and reveals the amount a unit of sales generates after direct and indirect costs are accounted for. Margin pressure here can be caused by external factors such as a higher tax bill or a hike in interest payments.
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