Profit margin

Profit Margin, net margin, net profit margin or net profit ratio is a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue.[1]

\text{net profit margin} = {\text{net profit}\over\text{revenue}}

where net profit is revenue minus cost

Overview

Profit margin is calculated with selling price (or revenue) taken as base times 100. It is the percentage of selling price that is turned into profit, whereas "profit percentage" or "markup" is the percentage of cost price that one gets as profit on top of cost price. While selling something one should know what percentage of profit one will get on a particular investment, so companies calculate profit percentage to find the ratio of profit to cost.

The profit margin is used mostly for internal comparison. It is difficult to accurately compare the net profit ratio for different entities. Individual businesses' operating and financing arrangements vary so much that different entities are bound to have different levels of expenditure, so that comparison of one with another can have little meaning. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss, or a negative margin.

Profit margin is an indicator of a company's pricing strategies and how well it controls costs. Differences in competitive strategy and product mix cause the profit margin to vary among different companies.[2]

Profit percentage

On the other hand, profit percentage is calculated with cost price taken as base

\text{profit percentage} = {\text{net profit}\over\text{cost price}}

Suppose you buy something for $100 and sell it off for $150.

cost price = $100
selling price (revenue) = $150
profit = $150 − $100 = $50
profit percentage (profit divided by cost) = $50/$100 = 50% profit percentage
R.O.I. (return on investment) multiple = $50/$100 (profit divided by cost). If your revenue is the same as your cost, that doesn't equate to 100% return on investment, it equates to 0%. The result above or below 100% can be calculated as the percentage of return on investment. In this example, the return on investment is a multiple of 0.5 of the investment, resulting in a −50% loss on ROI.

See also

References

  1. ↑ "profit margin Definition". Investor Words. InvestorGuide.com. Retrieved December 17, 2009.
  2. ↑ "profit margin". TheFreeDictionary.com. Retrieved December 17, 2009.
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