Which profitability ratios would you look at for a manufacturing company, and what does each tell you?

What the interviewer wants to hear

• Gross margin shows pricing power and direct cost control
• EBITDA margin shows operating efficiency before capital structure
• Net margin shows bottom-line profit after interest and tax
• ROE and ROCE show returns on capital invested
• Compare with history and peers

Model answer

I start with gross margin, which shows how well the company prices its products against raw material and direct costs. For a manufacturer, raw material price swings show up here first. Next is EBITDA margin, which adds overheads such as employee costs and power, and is useful to compare companies with different debt and depreciation. Net profit margin shows what is left for shareholders after interest and tax. Margins alone are not enough, so I also look at return on capital employed, which tells me how much operating profit the business earns on all the capital in plants and working capital, and return on equity for shareholders. I always compare these with the company over the last few years and with close peers, because a 10% EBITDA margin is strong in some industries and weak in others.

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