Profit margin is the amount of profit a business earns as a percentage after deducting the expenses. It measures how much a company earns for every dollar of revenue. Companies use this financial metric to understand their profitability and overall economic strength. Let’s know what a profit margin is and how to calculate a profit margin easily.
Profit margin is the amount of money a business earns after deducting its expenses. This financial metric is expressed in a ratio or percentage.
A 30% profit margin means the company earns $0.30 for each $1. After calculating the total revenue, all the business expenses, including taxes and interest, are assessed to measure the profit margin.
The simple formula of profit margin is given below:
Profit Margin (net income/total revenue) *100
For example, Net income = $20,000
Revenue = $60,000
Profit Margin = (20,000/60,000)*100 =33.33%.
Profit margin is mainly of three types. They are given below:
Gross profit margin is the money earned after deducting the cost of goods sold from revenue. It is then divided by revenue and multiplied by 100.
For example, Total revenue = $500
Cost of goods sold = $200.
Gross profit = $500 - $200 = $300
Gross profit margin = (300/500)*100= 60%.
For each $1 of revenue, the company earned $0.6 of gross profit.
Operating profit margin is the percentage of profitability after deducting the day-to-day operational costs from revenue.
For instance, Total revenue = $500
Gross profit = $300
Operating expenses = $100
Operating income = $300-$100 = $200
Operating profit margin = (200/500)*100=40%.
For each $1 of revenue, the company earned $0.4 of operating profit.
Net profit margin is the percentage of net income earned of the total revenue after paying all expenses and taxes.
For example, Total revenue = $500
Operating income = $200
Taxes & interest = $50
Net profit = $200-$50 = $150
Net profit margin = (150/500)*100 = 30%.
For each $1 of revenue, the company earned $0.30 of net profit.
The higher the profit margin, the more profit a company earns. The company can generate more returns for investors.
Not all business industries can earn the same percentage of profit margin. Let’s learn the average gross and net profit margin of some top sectors in the USA.
|
Industry |
Gross Profit Margin |
Net Profit Margin |
|
Healthcare |
40% to 60% |
5% to 10% |
|
Hospitals |
30% to 50% |
3% to 8% |
|
Automotive |
10% to 30% |
2% to 5% |
|
Grocery and Food |
15% to 35% |
2% to 5% |
|
Construction |
20% to 30% |
5% to 15% |
|
Insurance |
60% to 80% |
20% to 30% |
|
Hotel |
45% to 65% |
5% to 15% |
You can increase your profit margin by cutting down operational expenses and increasing sales units. The key is improving the overall business efficiency to earn the highest profit margin. Understanding profit margins helps a business attain its desired profitability and analyse the calculations better to achieve financial stability.
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