Lesson 7 of 10 · All lessons in this module
- Competitive strategy and positioning
- Strategy over the life cycle and addressable markets
- Generic strategies in practice: capacity, moats and two kinds of focus
- Revenue drivers: bottom-up and top-down
- Pricing power
- Operating costs and operating leverageVideo lesson
- Operating profitability and working capital
- Choosing a profit margin, cost components and price elasticity
- Capital investments and capital structure
- FCFE, net capex and financing across the life cycle
This lesson is part of the 2027 curriculum. You are following the 2026 curriculum, where it is not taught in this form. Switch if you are sitting the exam under the 2027 curriculum.
Lesson 7 of 10 · 15 min
Operating profitability and working capital
Margins built from functional cost lines (gross, EBITDA, EBIT), costs expressed as a percentage of revenue, and working capital measures (cash conversion cycle, net working capital to sales) show how efficiently a company turns revenue into profit and cash.
In short
- Most issuers present costs by function, giving three profitability measures: gross profit, EBITDA and operating profit (EBIT), each also as a margin on revenue.
- Cost of sales is mostly variable, so gross margin ≈ contribution margin. SG&A, R&D and D&A are largely fixed (with exceptions such as commissions).
- Over the long run output drives costs, even fixed ones, so analysts express costs as a % of revenue and look for economies of scale (lower unit costs with size) and economies of scope (shared costs across product lines).
- Industry profitability is set by competition, so do not judge margins company by company in isolation.
- Working capital: a short cash conversion cycle means less external financing; negative net working capital means suppliers finance the company.
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