A margin or profit margin represents the profit left behind after you take out costs. In our risk management models, the margin represents a forward looking calculation that takes into account the estimated cost of production, the projected cost of feed and finally the projected earnings from sales. We offer two unique margin calculations:

Net Margin based on Inputs and Positions
In the CIH risk management model, the “net margin based on inputs and positions” is calculated by first projecting revenues:

  • quantify how much the operation expects to produce and project sales revenue using the current commodity futures contract price
  • incorporate any gains or losses from cash or futures and options positions in the commodity that the operation sells

The following projected costs are then subtracted from projected revenues to arrive at a profit margin dollar amount:

  • calculate the projected cost of any inputs that can be hedged (priced using the current commodity futures contract price)
  • incorporate gains or losses from these hedges
  • combine all of the other projected costs to produce the commodity, including inputs that cannot be hedged using the futures market

Open Market Margin
The open market margin is a similar calculation but does not factor in gains and losses from cash or futures and options positions. It reflects the profit margin projected independent of any contracting or risk management. Comparing the net margin to the open margin therefore allows one to evaluate the effectiveness of their risk management strategy at any given point in time.

Margin as a Percentage

In traditional finance, margin is calculated as a percentage and reflects three different sets of costs on an income statement: Gross Margin, Operating Margin, and Net Margin.1

Gross Margin
Subtract raw material cost (“cost of goods sold”) from revenue and you get the gross profit amount. Dividing the gross profit by the gross revenue yields the gross margin.

Operating Margin
A second measurement includes staff salaries, rent, utility bills, and countless other expenses with the cost of goods sold. Subtract these costs from the gross profit to calculate the operating profit. Divide this figure by the gross revenue, and you’ll get the operating margin.

Operating margin expresses how well a company’s holding up against its own previous results. A lower operating margin year over year may mean a company’s becoming less efficient in its internal operations.

Net Margin
Finally, after items such as taxes and interest payments are accounted for, you’re left with net profit (more commonly known as net income), near the bottom of the statement. Dividing a companies’ net profit by its gross revenue yields a net profit margin. This number reflects how much of every dollar of sales a company keeps as profit — the rock-bottom fundamental view of its fiscal strength.

Source: 1. Selena Maranjian, The Motley Fool

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