Profit margin

Profit margin

Profit margin, Net Margin, Net profit margin or Net Profit Ratio all refer to a measure of profitability. It is calculated using a formula and written as a percentage or a number.

mathrm{Net profit margin} = frac{mathrm{Net profit after taxes}}{mathrm{Net Sales }}

The profit margin is mostly used for internal comparison. It is difficult to accurately compare the net profit ratio for different entities. Individual businesses' operating and financing arrangements vary so much that different entities are bound to have different levels of expenditure, so that comparison of one with another can have little meaning. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss.

For example, a company produces a loaf of bread and sells it for €10. It cost the company €6 to produce the bread and it also had to pay an additional €2 in tax.

That makes the company's net income €2 (10 - 6, before tax, then minus 2 for tax). Since its revenue is €10, the profit margin would be (2 / 10) or 20%.

Profit margin is an indicator of a company's pricing policies and its ability to control costs. Differences in competitive strategy and product mix cause the profit margin to vary among different companies.

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