Firms exploit inflation to pad their bottom lines

A debate is intensifying about the role of corporate America in the recent wave of higher inflation. Companies are undoubtedly raising prices. The question is whether they are exploiting a surge in consumer demand or merely passing on their own higher costs. The available data strongly suggests that companies are raising prices to enhance profits.
The view of price increases most generous to US companies is that constrained supply lines and labor shortages are raising the cost of doing business, forcing them to pass on those higher costs to consumers. A more skeptical view is that companies are raising prices because they can. Consumers are spending more, fueled by record amounts of fiscal and monetary stimulus, skyrocketing home prices, excess pandemic savings and pent-up demand from two years of isolation. The combination of higher demand and short supply gives companies an opening to raise prices.
Judging by their own financial statements, companies are seizing that opportunity. Starting from the top of the income statement and working down, the first point of interest is gross profit, which is the difference between a company’s sales and cost of goods. That’s accounting speak for simple math. Say someone runs a lemonade stand. If he sells a cup of lemonade for a $1 and it costs him 70 cents for the cup, lemons, sugar and water, his gross profit is 30 cents. His gross margin, which is the gross profit divided by sales, is 30%.
If companies are only passing on their own higher costs to consumers, their gross margins should stay roughly the same. But that’s not what’s happening. Gross margins for the S&P 500 Index rose to a record 35% last year from 34% the year before. And that’s just the beginning. This year, Wall Street analysts expect gross margins to shoot up to 45%, based in part on companies’ own projections. In other words, companies appear to be raising prices much higher than their cost of goods.
The next stop on the income statement is Ebit margin, which stands for earnings before interest and taxes. Ebit margin tacks on operating expenses such as wages, rent and utilities — basically everything except interest on debt and taxes. Ebit margins rose even more than gross margins last year to a record 16% from 10% the year before, which, perhaps not coincidentally, approximates the jump in inflation last year. Analysts expect Ebit margins to climb to 17% this year.

—Bloomberg