Every business dreams of becoming a profitable business. But this is a long journey for sure. With a lot of hustle, every sale takes place. When it comes to profit margin, it is the only financial statement to consider if a company is profitable or not. Profit margin is very important for any company’s financial backbone. If every cent that is coming from sales and going again into the investment portion, then the company can never be a financially strong one. It represents the percentage of sales that have tuned into profits. This can help you determine the company’s financial growth. But how can a person calculate a profit margin? Profit margin can be categorized into a couple of types.
Let’s dive into the details of profit margin in the following article.
How Can You Properly Calculate Profit Margin?
Probably, the Profit margin is the easiest and simplest finance ratio in corporate finance. Profit margin can be mainly divided into three types they are Gross profit margin, Net profit margin, and operating profit margin. Let’s suppose a business is generating $X as its gross sales, $Y as the business expenses, and $Z as the earnings. So profit margin is that number that is calculated in real-time to state a business’s profitability. Now let’s discuss how an owner can calculate the profit margin.
How to Calculate Gross Profit Margin?
Gross profit margin is the easiest metric used in the business finance department. It shows that number as a profit which remains after doing the accounting for COGS(cost of goods sold).
COGS is mainly that amount that is directly related to the production or manufacture of the item for sale. It includes the cost of raw materials and labor charges also. But the GPM does not include any other expenses like debt, taxes, and overhead costs or one-time expenditures such as purchasing any equipment. Gross profit margin calculates the gross profit from the total revenue after paying the COGS.
We can use a simple formula to calculate the Gross profit margin, and that is
GPM = {(Net sales -COGS) ÷ Net sales}x 100
GPM stands for Gross profit margin.
Operating Profit Margin Calculation
Operating profit margin is a kind of more difficult financial term that includes all overhead, administrative, and sales expenses that are necessary to run a business on a day-to-day basis.
While this also excludes debts or business taxes. However, it includes the depreciation of assets in itself. When you get done calculating the operating profit margin out of the whole revenue, it shows the profitability margin in each dollar after paying all the necessary expenses to run a business.
You can calculate the Operating profit margin using this formula.
OPM = (Operating income ÷ Revenue) x 100
Where OPM stands for Operating profit margin.
How to Calculate Net Profit Margin?
The notorious net profit margin shows the whole scenario of turning income into profit in a company’s financial guidelines. This shows the revenue that is left over after all expenses, including all income streams.
This type of profit margin not only includes COGS, administrative expenses, or any other operational expenses but also includes taxes, debts, and one-time expenses.
A person can use two formulas to calculate the net profit margin.
NPM= {(R – CGS – OPE – OTE – I –T)÷ R} x 100
Or
NPM= (NET INCOME ÷ R) X 100
Where,
NPM= Net profit margin
R= revenue
CGS= cost of goods sale
OPE= operating expenses
OTE= other expenses
I= Interest
T= Taxes
What is the Profit Margin?
In simple words, the profit margin is the ratio that tells us whether a company is making money or not. It highly reflects how much sales have turned into sales or how many cents in a dollar the company is making as profit. Now we know that there are basically three types of profit margins that can state a company’s financial condition. So, during an investment, an investor considers the profit margin as the key investment point. It shows the financial condition or well-being of the company. However, it can be differentiated into a couple of types, as we discussed above.
Well, sometimes you need a professional tax accountant just for giving proper attention to your profit margin and taxes. if you are tense regarding these financial things, you can hire a tax accountant, who will be always there for your company’s financial health.
How Can We Analyze the Profit Margin Formula?
The profit margin formula mainly depends on two numbers, which are sales and expenses. Any company can increase its profit margin in two ways. That can be either by increasing sales numbers or decreasing manufacturing expenses.
As an example, if a company is making $150000 by selling their product in total and total expenses are $75000, then the profit margin can be easily calculated as 50%. But if the expense gets a lower amount and comes to $30000, then the margin will be 80%. So we can say that any company can increase its profit margin by decreasing expenses.
On the other hand, if a company is making $150000, its total revenue and expenses are about $75000. In that case, The profit margin is 50%. But if the company increases the sales amount and the expense remains the same. The profit margin will increase in that case also.
For higher sales, a manufacturer can decrease the price or increase the selling unit. But that completely depends on the competitor’s edge in the market. It also depends on other market dynamics like demand and supply, market share, market position, and competitors’ existing position.
To Wrap it Up
In some last words, we can consider the profit margin as a company’s key financial point. Only it can say about the company’s financial condition. Profit margin is the profit that a company makes from each of its sales. The number of cents in a dollar can be differentiated from the total revenue, and the expense is the profit in a product sale. This margin is of three types, and every type of profit margin depends on different factors. Some depend on taxes and debts, while some don’t. So, this was a detailed look at how to calculate profit margin.
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Frequently Asked Question
What is the difference between gross profit margin and net profit margin?
The gross profit margin does not include debts, taxes, or any overhead expenses while calculating. But a net profit margin includes all types of expenses like debts, taxes, and overhead expenses.
How can we calculate the operating profit margin?
A person can easily calculate the operating profit margin by using this formula.
OPM = (Operating income ÷ Revenue) x 100
Here, OPM stands for Operating profit margin.
What is a profit margin of 50%?
In simple words, a profit margin of 50% means if the company expends $1 to manufacture a product, then it earns $2 by selling it. This way, it generates a profit of $1.
What is the difference between profit margin and ROI?
ROI stands for return on investment. The main difference between these two is that a profit margin can never cross 100%, while ROI can go beyond 100%.
