Profit Margin Formula

The profit margin tells us whether the business is doing well or not. It shows what percentage of the revenue comprises profit, excluding business costs and expenses. In business finance, profit margin tells us how much the business make on the sale of each product or service. While it seems logical, there are many things small business owners either they are not aware about profit margin or forget about profit margins. The owner can use the profit margin to assess good goals for in their small business. Here, we shall discuss the Profit Margin formula in detail.

Profit Margin Formula

What is the Profit Margin Formula?

Profit margin gauges the degree to which a company or a business activity makes money, essentially by dividing income by revenues. It is represented as a percentage, profit margin indicates the percentage of profit has generated for each item of sale.

Creditors, investors, and businesses themselves as indicators of a company’s financial health, management’s skill, and growth potential use profit margins. As typical profit margins vary by industry sector, care should be taken when comparing the figures for different businesses.

The profit margin formula is the net income divided by net sales. The net sale includes gross sales from which we deduct discounts, returns, and allowances. In other words, the net sale is the total revenue excluding expenses.

To calculate the profit margin of a business, the following formula:

Profit Margin = \(\frac{Net Income}{Net Sales​}×100​ \)

Types of Profit Margins

Gross profit margin: We use gross profit margin to determine the profit margin of a single product or service, not of an organization as a whole. To determine the gross profit margin,

Gross profit margin= \(\frac{Net sales − COGS}{Net sales}\)

Where,

COGS	cost of goods sold

Net profit margin: We use net profit margin to determine an entire organization’s profit margin. The net profit margin is calculated by taking the company’s net income for a given period and dividing by net sales.

Net Profit Margin = \(\frac{Revenue}{Net income​}×100​ \)

Why Profit Margin Is Important?

Profit margin is important because by calculating it we can determine whether the company position in the market is good or not. It helps us grow our business. The profit margin helps us to flag and resolves issues related to the loss or profit so that the position of the company becomes strong in the market. It is important for financing purposes also.

What Is a Good Profit Margin?

A good profit margin depends on your industry and expansion goals and a host of other factors, like the economy. It can sometimes seem like comparing two different things. Some factors that affect what makes a good profit margin are industry specifics means there are some companies, which provide high-profit margins such as alcohol, software and gaming industries, etc.

Expansion goals are also important factors because profit margin gives a clear picture of the status of the company. Longevity and size of the company is another factor which is important because as the company grows profit margins increases.

How Can You Improve Your Profit Margin?

A few ways to improve profit margins are to decrease expenses, cut underperforming products or services, increase product offerings or services, and increase pricing.

Solved Example

Q.1. A business realized net sales worth Rs. 100,000 in the previous quarter and spent a total of Rs. 80,000 towards various expenses. You need to calculate the Profit margin.

Solution: Profit Margin = \(\frac{Net Income}{Net Sales} \times 100\)

Profit Margin  = \(\frac{80,000}{100,000} \times 100\)

= 100% – 80%

= 20%