Profit Margin
What is profit margin?
Profit margin is a measure of how much of every dollar a company brings in a sales it keeps after costs as earnings. Profit margin is also called “Net Profit Margin,” “Net Margin,” and “Net Profit Ratio.”
How is profit margin calculated?
Profit Margin = (Net Profit / Revenue) * 100
Net Profit is a company’s gross profit minus overhead, interest, and generally taxes as well; where gross profit is defined as revenue minus the costs of manufacturing a product or providing a service.
For example, if company X has net profit of $100 million on revenue of $500 million, its profit margin is 20% [ (100 / 500) * 100 ].
Why is profit margin important?
A high profit margin indicates that a company has flexibility in its pricing because a small reduction in pricing will not erase its profits.
Profit margins for companies in different industry cannot be compared directly, however, as the costs of operating and financing a business in different sectors vary greatly and monopoly pricing capabilities from patents may or may not apply. For example, the average profit margin of “major drug manufacturers,” more commonly called pharmaceutical companies, was 17.6% in 2009 while the average profit margin of “grocery stores” is 1.5%.