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The full import of shrinking corporate margins

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Gross profit margins of the industry have been witnessing a squeeze against the background of the corporate sector grappling with increased commodity prices and sluggish consumer demand. Mint explains what this means.

Gross profit margins of the industry have been witnessing a squeeze against the background of the corporate sector grappling with increased commodity prices and sluggish consumer demand. Mint explains what this means.

What does gross profit margin squeeze mean?

Gross profit margin is the percentage of revenue remaining after the cost of goods sold is deducted. It is derived by subtracting this cost from net sales and dividing the result of the subtraction by net sales. The cost of goods sold includes direct costs incurred in production, such as wages and raw material costs. A decline in sales volume and an increase in the prices of raw materials and labour charges could be some of the factors that adversely impact gross profit margin. The corporate sector has, of late, been experiencing a narrowing of gross profit margin because of increasing input costs.

What is causing a squeeze in margins

International commodity prices have been rising, according to the Financial Stability Report, July 2021. Commodity markets have been shattering records, and price pressures on commodities such as crude and base metals have been high. This has resulted in increased commodity prices, which has led to a rise in input costs. Thus, per unit cost of production for firms has risen, leading to a reduction in gross profit margins. Chemicals, capital goods, and the auto sector have been hit by higher raw material and freight costs, while the technology sector has been hit because of attrition-led supply pressure on profit margins.

Rising prices
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Rising prices

What has been the trend on corporate margins?

The prices of commodities such as copper, steel, aluminium, and polyprop rose by 44%, 38%, 22%, and 29%, respectively, resulting in margins of the consumer durables sector declining by 2-5% in 2HFY21. The automobile sector in 1QFY22 has been adversely impacted because of rising raw material cost and has reported a commodity cost impact of 3-4 pp q-o-q.

What is at stake for the general public?

Firms may be compelled to absorb high  production costs. But with the festival season setting in and pick-up in vaccination leading to demand revival, there would be an rise in sales volumes. It would give firms the confidence to pass on the burden of increased cost of production to consumers, thus resulting in higher output costs and increased prices for consumers. Inflation which was being viewed as ‘transitory’ has been forcing firms to run out of room to absorb raw material costs, and it is only a matter of time before the pass-on happens.

Who are the other stakeholders?

Corporate tax collections will be adversely affected, leading to negative effects on welfare schemes and developmental activities. It will also put further stress on fiscal deficit. For firms, too, the balancing act to protect squeezed margins and strategize for sluggish demand could result in shareholders’ dividend earnings being affected. Also, with lower profit margins, reinvestment plans of firms are likely to be hit, leading to lower private sector investment levels.

Jagadish Shettigar and Pooja Misra are faculty members at BIMTECH.

 

 

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