What is a ‘Profit Margin’
Profit margin is a profitability ratio calculated as net income divided by revenue, or net profits divided by sales. Net income or net profit may be determined by subtracting all of a company’s expenses, including operating costs, material costs (including raw materials) and tax costs, from its total revenue. Profit margins are expressed as a percentage and, in effect, measure how much out of every pound of sales a company actually keeps in earnings. A 20% profit margin, then, means the company has a net income of £0.20 for each pound of total revenue earned.
While there are a few different kinds of profit margins – including “gross profit margin,” “operating margin,” (or “operating profit margin”) “pre-tax profit margin,” and “net margin” (or “net profit margin”) – the term “profit margin” is also often used simply to refer to net margin. The method of calculating profit margin when the term is used in this way can be represented with the following formula:
Profit Margin = Net Income / Net Sales (revenue)
Other types of profit margins have different ways of calculating net income so as to break down a company’s earnings in different ways and for different purposes.
Profit margin is similar but distinct from the term “profit percentage,” which divides net profit on sales by the cost of goods sold to help determine the amount of profit a company makes on selling its goods, rather than the amount of profit a company is making relative to its total expenditures.
