How To Analyze Profit Margin Results

Profit margins are perhaps one of the simplest and most widely used financial ratios in corporate finance. A company’s profit is calculated at three levels on its income statement, starting with the most basic—gross profit—and building up to the most comprehensive: net profit. Between these two lies operating profit. All three have corresponding profit margins calculated by dividing the profit figure by revenue and multiplying by 100.

Profit Margin, Gross Margin, and Operating Margin – With Income Statements

How to find a profit margin ratio

You can use a profit margin formula to calculate the profit ratios of your current sales with the following steps:

What is a profit margin formula?

A profit margin formula is a method used to calculate profits within a business. Determining how much income a business brings in does not necessarily offer insight into their operating costs, expenses, taxes or other debts. It does not give a true calculation of how much income is actually considered profit. In comparison, the profit margin describes the percentage of a dollar that is actually profit.

Profits are divided into three types: gross, operating and net profits. Each type of profit has a formula that you can use to calculate it. Profit margins are important to a business because they can determine the value of the business before buying or selling. You can also use profit margins to identify strengths and weaknesses in a business. For example, good profit margins in one area and lower profit margins in another may indicate that there is a problem with a specific part of the business.

Profit margins demonstrate what percentage of income has been turned into profits. This can help a business make important decisions. For example, if a business has high operating costs that decrease profit margins, their labor cost may be too high. If the cost of goods sold decreases profit margins, the business might need to find a supplier or begin manufacturing in-house to reduce these costs. Profit margins provide businesses with valuable information that they can use to improve their business practices.

How to analyze profit margin ratio results

Once you calculate the profit margin, the next step is to analyze the information. You can analyze the profit margin ratio with the following steps:

Elements of a profit margin formula

Its helpful to understand what other elements may be needed when calculating profit margins. Some of these elements require their own calculations. Additional information that you may need when calculating profit margins include:

Most of these elements can be found on the profit and loss statement. You can input them into the formulas to determine a companys profit margins.

Profit margin formula templates

You can use the following templates to calculate the gross, operating and net profit margins:

Gross profit margin formula

Gross profit is the income earned after accounting for the cost of goods sold. This formula does not account for debt, overhead costs, taxes or any other one-time costs. You can use the gross profit margin formula to calculate the profit margin of a single product or good rather than the business as a whole. The formula for gross profit margins is:

Gross profit margin = (net sales – COGS) / net sales

Operating profit margin formula

The operating profit is a calculation that takes into account a few of the factors that gross profit leaves out, including administrative and overhead costs. It also includes the amortization and depreciation of assets. The operating profit still excludes certain costs, like debts and taxes.

To use this formula, you may need to first calculate the operating income. This formula is:

Operating income = revenue – COGS – operating costs

The formula for operating profit margins is:

Operating profit margin = (operating income / revenue) x 100

Net profit margin formula

Net profit margin refers to the net income of a business. It is the income left after all expenses are paid, and it takes into consideration costs left out in the other formulas. It includes COGS, operational expenses, taxes, debt payments and other income sources. The net profit is often used to determine how well a business reduces its expenses and turns income into actual profits. First, you need to calculate net income with the following formula:

Net income = revenue – COGS – operating expenses – other expenses – interest – taxes

Then, you can input the net income into the following net profit margin formula:

Net profit margin = (net income / revenue) x 100

Profit margin examples

Here are a few examples using the templates above to calculate profit margins:

Gross profit margin

Delta Deals is calculating the profit margins of their online sales business. This year, they earned $400,000 in revenue, but they want to know how much of this revenue is profit. They want to calculate the gross, operating and net profit margins to get a clearer understand of profits. Delta Deals spent $184,000 on the cost of goods sold, so their gross profit margin formula is as follows:

Gross profit margin = ($400,000 – $184,000) / $400,000

Gross profit margin = 0.54 or 54%

Operating profit margin

Delta Deals calculated the operating costs, which include $42,000 in administrative expenses and $22,000 in operating expenses. This allows them to calculate their operating income by subtracting the cost of goods sold and operating costs from their revenue:

Operating income = $400,000 – $184,000 – $42,000 – $22,000

This comes out to $152,000, which they can input into the operating profit margin formula:

Operating profit margin = ($152,000 / $400,000) x 100

Operating profit margin = 38%

Net profit margin

To find the net profit margin, Delta Deals calculated their net income. They had an additional $24,000 in debt payments and $20,000 in taxes to include.

Net income = $400,000 – $184,000 – $64,000 – $24,000 – $20,000

This comes out to $108,000 in total for net income, which they can input into the net profit margin formula:

Net profit margin = ($108,000 / $400,000) x 100

Net profit margin = 27%

FAQ

How do I calculate a 20% profit margin?

How to calculate profit margin
  1. Find out your COGS (cost of goods sold). …
  2. Find out your revenue (how much you sell these goods for, for example $50 ).
  3. Calculate the gross profit by subtracting the cost from the revenue. …
  4. Divide gross profit by revenue: $20 / $50 = 0.4 .
  5. Express it as percentages: 0.4 * 100 = 40% .

What is the profit margin?

How do you calculate a 20% profit margin?
  1. Use 20% in its decimal form, which is 0.2.
  2. Subtract 0.2 from 1 to get 0.8.
  3. Divide the original price of your good by 0.8.
  4. The resulting number is how much you should charge for a 20% profit margin.

Related Posts

Leave a Reply

Your email address will not be published.