What Is a Margin?
For any business owner, the only important margin is the profit margin. It represents the profit generated after accounting for the expenses.
When it comes to finances, the meaning of a margin is very different. It represents security collateral the investor must deposit before borrowing money from the broker or exchange for stock trading.
Let’s take a look at each one of them in more detail.
Margin in Business
When running a business, it’s essential to have a clear idea about its profitability at any time.
The sales and earnings alone aren’t enough to provide a complete picture. That is why businesses use profit margins.
There are four types, each of which calculates a profit margin within specific parameters.
- Gross profit margin
- Operating profit margin
- Pretax profit margin
- Net profit margin
The gross profit margin shows how much the business makes after subtracting the cost of the goods sold.
The operating profit margin is calculated by subtracting operating expenses (selling, general, and administrative) from the gross profit. This is also known as earnings before interest and taxes (EBIT).
If business owners want to calculate operating efficiency, they will use the pretax profit margin. It shows the percentage of sales that have turned into profit before deducting taxes. In other words - how much money is made for each sales dollar.
To know how much the company actually earns, we need to calculate the net profit margin. We do this by dividing the net income by the company's revenue over a given period.
Having covered margins in the business world, let’s talk about what the term means in finance.
Margin in Finance
For an investor to be able to buy any kind of stock, they have to open a brokerage account. There are two types: cash and margin accounts, and both have their pros and cons.
The important thing to know is that with margin accounts, investors can borrow money from the broker to buy more securities than they would be able to otherwise. This is also called margin investing or margin trading. Before we go any further, let’s explain what securities are.
The Securities and Exchange Commission (SEC) defines the term as ownership or debt that has value and can be traded further. Stock gives us the ownership of a publicly-traded company which we can trade or hold onto until it gains value, making it a type of security.
Before the investor can borrow money for further purchases, they first need to deposit 50% of the amount they wish to borrow in cash or other securities. This deposit is also known as the initial margin.
Some brokerages may ask for a bigger deposit. That’s why it’s essential to find a broker that suits your needs and gives you the best deal.
The investor can invest more from their own budget, but they’ll need to cover at least 50% of the value they are borrowing, as that is the minimum amount allowed by The Federal Reserve Board. The FRB also regulates which companies can be traded using this system.
There is also a minimum amount that has to be on the account, which is called the maintenance margin.
It’s currently set to 25% of the total value of the securities by the Federal Reserve Board, but some brokerages may require it to be higher.
If the investor fails to maintain the minimum maintenance margin, the brokerage will make a margin call.
This is essentially a demand for more funds to become available on the account. The brokerage firm will sell all the investments if no further funds can be added to the account.
For years, the clients I worked for were banks. That gave me an insider’s view of how banks and other institutions create financial products and services. Then I entered the world of journalism. Fortunly is the result of our fantastic team’s hard work. I use the knowledge I acquired as a bank copywriter to create valuable content that will help you make the best possible financial decisions.
