Thread by @jpr007

@ModelQ23 @ConwayYen "What's the difference between gross margin and operating margin?"

A lot

Let's see if I can illustrate it clearly enough with my existing slides on the Auto business

1. In the picture here we can see the average selling price of a Tesla car in 2020 Q3 as $54,523

@ModelQ23 @ConwayYen 2. The two Red parts of the bar represent the Cost of Goods

Which is all of the direct costs of actually making the vehicle, including :

- Raw Materials

- Parts and Components

- Energy

- Labor

- Equipment

- Factory

- Manufacturing Overhead including Factory Management

@ModelQ23 @ConwayYen 3. Most of those are Costs that get paid in Cash at the time of production

- but the Factory Buildings and Equipment had to be built in advance so they are already paid for and instead get charged as a non-Cash Depreciation charge to "recover" those investments

@ModelQ23 @ConwayYen 4. Here are the numbers for each of the automakers that would go into making that chart

First, the total number of vehicles that they sold

@ModelQ23 @ConwayYen Second, the Automotive Revenues from selling those vehicles

@ModelQ23 @ConwayYen Third, the Revenue per Vehicle that comes out of those two numbers

- that gives us the "top line" on a per vehicle basis

@ModelQ23 @ConwayYen Fourth, the Automotive Cost of Goods for each company

@ModelQ23 @ConwayYen Fifth, the Automotive Cost of Goods per Vehicle can then be calculated by dividing the total Automotive Cost of Goods by the Number of Vehicles

@ModelQ23 @ConwayYen Sixth, when we deduct that Automotive Cost of Goods from the Automotive Revenues we get the Automotive Gross Profit

- which is that White area shown at the top of the left-hand bar on the first chart that we started with above

@ModelQ23 @ConwayYen Seventh, we can calculate that Automotive Gross Profit on a per Vehicle basis by dividing with the number of Vehicles

@ModelQ23 @ConwayYen Eighth, some OEMs include their R&D Costs in their Cost of Goods Sold but others do not

So to make the numbers consistent we take out the R&D Costs and come back to them in a later part of the analysis

@ModelQ23 @ConwayYen Ninth, so far we have shown these numbers in Dollars, but it is typically more useful to show them as a percentage of Revenues

- and for any industry we call this the "Gross Margin"

- it is the percent of Revenues left over after taking into account the actual Product Costs

@ModelQ23 @ConwayYen 5. So now we should be able to say that we know what "Gross Margin" is

To get to "Operating Margin" we need to deduct the other Operating Costs, which are typically :

- R&D

- Marketing

- Selling

- Administration

- and General costs

The last four are often called "Overhead"

@ModelQ23 @ConwayYen 6. These are reported as company-wide costs and may not just be for the Automotive business, depending on each company

Here are the R&D Costs in total Dollars

@ModelQ23 @ConwayYen And here are the same R&D Costs in percent of Automotive Revenues

@ModelQ23 @ConwayYen 7. Here are the Overhead Costs in total Dollars

- again we have adjusted the numbers so that R&D Costs are separated out and shown consistently as a separate category in the previous charts

@ModelQ23 @ConwayYen And here are the same Overhead Costs as a percent of Automotive Revenues

@ModelQ23 @ConwayYen 8. Now if you simply subtract those Costs for R&D and Overhead from the Gross Profit calculated earlier, you will get the Operating Profit

Which shows you the real profitability of the company

- at least before counting Interest Income and Expense, any other Stuff, and Taxes

@ModelQ23 @ConwayYen And we can do the same thing in terms of percentages of Revenue, which are easier to compare across companies of different sizes

This is what we call "Operating Profit Margin" or OPM

@ModelQ23 @ConwayYen 9. Just to complete the story, there are several other things that still need to happen to a company's profits

First is the deduction of any other Costs and Net Interest Expense and Income Taxes

This will leave us with the company's Reported Net Income

@ModelQ23 @ConwayYen Second, there are some further adjustments to this Net Income profit that get made in the "Statement Of Comprehensive Income"

- like Foreign Exchange adjustments

- and the Pension Liability adjustments that VW frequently makes

And this leaves us with the Comprehensive Income

@ModelQ23 @ConwayYen Comprehensive Income is the most realistic representation of a company's true profits in their financial statements

But it is not necessarily the same as the change in their Shareholders Equity because of Dividend Payouts, Stock Buybacks, and Capital Raises

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