What is Profit Margin
Profit margin is a financial ratio that measures the number of profits earned per dollar of sales. The profit margin can be calculated by dividing the net income by the net sales. The value of the profit margin is the percentage of sales left after all company expenses are deducted.
The profit margin ratio is frequently used to determine the operating effectiveness of management. To put it simply, it determines the ability of a company to make money. Profit margin is also known as return on sales (ROS).
For example, a 5% of profit margin means the company makes 5 cents on each dollar of sales.
The more profit margin number reflects the effectiveness of management. In contrast, the lower profit margin may be a result of the ineffectiveness of management. However, the different industries may have different bases profit margin values, this is the reason why you need to compare the profit margin with rivals in the same industry instead of a random company.
Additionally, it helps investors decide whether a company has enough earnings to cover its expenses and make a profit.
Profit Margin Formula
The profit margin can be calculated by dividing the net income by the net sales, or the following profit margin formula:
Profit Margin = (Net income / Net sales) x 100
The result is expressed as a percentage.
Let’s say the Feriors company had the following financial results:
- Net income of $2,000
- Net sales of $10,000
Profit Margin = 2,000 / 10,000 = 20%
This means the company makes 20 cents on each dollar of sales.
Profit margin is a financial ratio that measures profits earned per dollar of sale, calculated by dividing net income by net sales.
Profit Margin = Net income / Net sales
The higher profit margin number reflects the effectiveness of management.