How Do You Work Out a Profit Margin?

Work out a profit margin by dividing a measure of the company's profitability by the revenue, or sales, figure. There are a few different calculations for profit margins, depending on what data is required

Profit margins provide a measure of profitability by illustrating the relationship between a company’s earnings, as per its income statement, and its sales. The ratios can provide guidance on operating performance by reflecting cost and revenue trends. The data is useful for creditors and investors because it can indicate how well a company converts sales into income. Low profit margins are often viewed negatively, as they imply poor profitability. However, this assumption is not always correct, as the margin levels may reflect the nature of the industry.

The overall profit margin, or net profit margin, reflects the company’s income, net of all expenses, divided by sales. This metric can provide a gauge for meaningful comparison with a company’s peer group. In addition, it allows investors to compare the current performance with past trading periods.

The gross profit margin is calculated by dividing the gross profit by the sales figure (less the cost of goods sold). Again, this is expressed as a percentage. This metric captures the relationship between sales and associated manufacturing costs and can be used in association with other metrics. For example, a gross profit margin that remains that constant while the net profit margin is declining could indicate poor control over expenses.

Another metric used for analysis is the operating profit margin, which is calculated by dividing the company’s operating income by its sales. This provides information on the profitability of the company’s core business, excluding the effects of income from affiliates or asset sales, interest expense and tax.