What is profit margin
Profit margin is the amount of profit that makes up the revenue. The higher the margin, the more you are left with.
Profit margin definition
Profit margin is a measure of a company’s profitability, indicating the percentage of profit earned in relation to its revenue.
Expressed as a percentage, it signifies how many cents of profit a company generates for each dollar of sales. For instance, a 35% profit margin means the company keeps $0.35 as profit from each dollar of sales.
How profit margin works
Businesses engage in economic activities with the primary goal of making a profit.
While revenue and earnings figures are useful, profit margin offers a more nuanced view of a company’s performance over different time periods. There are several types of profit margins, with the most significant being the net profit margin, calculated after considering all expenses, including taxes.
Types of profit margins
- Gross Profit Margin: Revenue minus the direct costs of producing goods or services.
- Operating Profit Margin: Gross profit minus indirect costs like overhead, advertising, and R&D.
- Pre-tax Profit Margin: Operating profit plus or minus interest and any unusual charges.
- Net Profit Margin: Pre-tax profit minus taxes, representing the bottom line.
Comparing profit margins
While profit margin is a valuable metric, it has limitations when comparing companies.
Industries with low-profit margins, like retail and transportation, might still be profitable due to high turnover and revenue. Therefore, caution is required when comparing profit margins across different business types.