Sunday, February 23, 2020
Tuesday, February 18, 2020
In Spain, private sector credit as a share of GDP almost doubled between 2000 and 2007. This increase was accompanied by a boom in housing prices—which doubled in real terms over the same period. The economy as a whole also grew at a record pace.
But then in 2008, Spain’s credit bubble burst, and with it came loan defaults, bank failures, and a prolonged economic slowdown.
A less-noticed development in Spain was in the construction sector, where employment grew by an astounding 47 percent, compared to the economy-wide increase of 27 percent.
New IMF staff research, based on a large sample of advanced and emerging market economies since the 1970s, shows that long-lasting credit booms that featured rapid construction growth never ended well.
New evidence on credit booms
Rapid credit growth—known as “credit booms”—presents a trade-off between immediate, buoyant economic performance and the danger of a future crisis. The risk of a “bad boom”—where a rapid credit growth episode is followed by a financial crisis or subpar economic growth—increases when there is also a boom in house prices.
Our research shows that the experience with the dangerous combination of credit booms and rapid expansion in the construction sector goes beyond the Spanish borders and extends to time periods not related to the global financial crisis.
We find that signals from construction activity may help to tell apart the dangerous booms, which need to be controlled, from the episodes of buoyant but healthy credit growth (“good booms”).
Credit booms do not lift all boats alike
During booms, output and employment expand faster. But not all sectors behave the same. Most of the extra growth is concentrated in a few industries—specifically, construction and, at a distant second, finance.
However, the same industries that benefit the most during booms experience the most severe downturns during busts. This implies that credit booms tend to leave few long-term footprints on a country’s industrial composition.
Construction is special
Construction is the only sector that consistently behaves differently between good and bad credit booms. On average, output and employment in the construction sector grow between 2 and 3 percentage points more in bad booms than in good ones. In all other sectors, the difference is smaller and not significant (except trade, but only when it comes to output growth).
What makes construction special? Construction does not have the growth potential of many other industries. In other words, too much investment in construction may divert resources away from more productive activities and result in lower output.
Also, the temporary boost in construction employment and the relatively low level of skills needed may discourage some workers from investing in their education and skills. This may have long-lasting effects on output after the boom ends.
Finally, construction projects have large up-front financing needs, and final consumers of the product (for example, houses or hotels) also tend to borrow to finance their purchases. As a result, debt may increase significantly more during booms led by construction.
The predictive power of construction activity
An unusually rapid expansion of the construction sector helps flag bad credit booms. A 1 percentage point increase in output and employment growth in the construction sector during a boom raises the probability of the boom being bad by 2 and 5 percentage points, respectively.
Construction growth is also a strong predictor of the economic costs of bad booms than other variables. A 1 percentage point increase in output growth in the construction sector during a bad boom corresponds to nearly a 0.1 percentage point drop in aggregate output growth during the bust.
If policymakers observe a rapid expansion in the construction sector during a credit boom, they should consider tightening macroeconomic policies and using macroprudential tools (such as higher down payments for mortgages).
In some cases, policy action will be triggered by other indicators, such as house prices or household mortgages. Sometimes, however, these other indicators may not sound the alarm (for example, because the construction boom is financed by the corporate sector or by foreigners), yet risks accumulate. Then, unusually rapid growth of construction could give a signal, for instance, to impose limits on banks’ exposure to real estate developers and other construction firms.
Finally, given that data on output and employment in the construction sector are often available with a few months’ lag, higher-frequency indicators such as construction permit applications could act as valuable signals. Construction indicators should also be included in models that assess risks to future economic activity.
Saturday, February 15, 2020
What Is Net Profit Margin?
The net profit margin is equal to how much net income or profit is generated as a percentage of revenue. Net profit margin is the ratio of net profits to revenues for a company or business segment. Net profit margin is typically expressed as a percentage but can also be represented in decimal form. The net profit margin illustrates how much of each dollar in revenue collected by a company translates into profit.
Net income is also called the bottom line for a company or the net profit. Net profit margin is also called net margin. The term net profits is equivalent to net income on the income statement, and one can use the terms interchangeably.
Calculation for Net Profit Margin
- On the income statement, subtract the cost of goods sold, operating expenses, other expenses, interest (on debt), and taxes from revenue.
- Divide the result by revenue.
- Convert the figure to a percentage by multiplying it by 100.
- Alternatively, locate net income from the bottom line of the income statement and divide the figure by revenue. Convert the figure to a percentage by multiplying it by 100.
What Does Net Profit Margin Tell You?
The net profit margin factors in all business activities including:
- Total revenue
- All outgoing cash flow
- Additional income streams
- COGS or cost of goods sold and other operational expenses
- Debt payments including interest paid
- Investment income and income from secondary operations
- One-time payments for unusual events such as lawsuits and taxes
Net profit margin is one of the most important indicators of a company's financial health. By tracking increases and decreases in its net profit margin, a company can assess whether current practices are working and forecast profits based on revenues. Because companies express net profit margin as a percentage rather than a dollar amount, it is possible to compare the profitability of two or more businesses regardless of size.
Investors can assess if a company's management is generating enough profit from its sales and whether operating costs and overhead costs are being contained. For example, a company can have growing revenue, but if its operating costs are increasing at a faster rate than revenue, its net profit margin will shrink. Ideally, investors want to see a track record of expanding margins meaning that net profit margin is rising over time.
Most publicly traded companies report their net profit margins both quarterly during earnings releases and in their annual reports. Companies that can expand their net margins over time are generally rewarded with share price growth, as share price growth is typically highly correlated earnings growth.
Net vs. Gross Profit Margin
Gross profit margin is the proportion of money left over from revenues after accounting for the cost of goods sold (COGS). COGS are raw materials and expenses associated directly with the creation of the company's primary product, not including overhead costs such as rent, utilities, freight, or payroll.
Gross profit margin is the gross profit divided by total revenue and is the percentage of income retained as profit after accounting for the cost of goods. Gross margin is helpful in determining how much profit is generated from the production of a company's goods because it excludes other items such as overhead from the corporate office, taxes, and interest on a debt.
Net profit margin is the percentage of profit generated from revenue after accounting for all expenses, costs, and cash flow items.
Limitations of Net Profit Margin
Net profit margin can be influenced by one-off items like the sale of an asset, which would temporarily boost profits. Net profit margin doesn't hone in on sales or revenue growth, nor does it provide insight as to whether management is managing its production costs.
It's best to utilize several ratios and financial metrics when analyzing a company. Net profit margin is typically used in financial analysis, along with gross profit margin and operating profit margin.
Imagine a company that has the following numbers reported on its income statement:
- Revenue: $100,000
- Operating costs: $20,000
- COGS or cost of goods sold: $10,000
- Tax liability: $14,000
- Net profits: $56,000
Net profit margin is thus 0.56 or 56% ($56,000/$100,000) x 100. A 56 percent profit margin indicates the company earns 56 cents in profit for every dollar it collects.
Let's take another hypothetical example using the made-up Jazz Music Shop's FY 2025 income statement.
Here, we can gather all of the information we need to plug into the net profit margin equation. We take our total revenue of $6,400 and deduct variable costs of $1,700 as well as fixed costs of $350 to arrive at a net income of $4,350 for the period. If Jazz Music Shop also had to pay interest and taxes, that too would have been deducted from revenues.
Real World Example
Below is a portion of the income statement for Apple Inc. (AAPL) as reported for the quarter ending on December 29, 2018:
- Net sales or revenue was $84.310 billion (highlighted in blue).
- Net income was $19.965 billion for the period (highlighted in green).
- Apple's net profit margin is calculated by dividing its net income of $19.965 billion by its total net sales of $84.310 billion. Total net sales are used as the top line for companies that have experience customer returns of their merchandise, which are deducted from total revenue.
- Apple's net profit margin was 23% or ($19.965 billion ÷ $84.310 billion) x 100.
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