Several different quantitative measures are used to compute the gains (or losses) a business generates, which make it easier to assess the performance of a business over different time periods, or compare it against competitors.
Profit margin is one of the commonly used profitability ratios to gauge profitability of a business activity. It represents how much percentage of sales has turned into profits. Simply put, the percentage figure indicates how many cents of profit the business has generated for each dollar of sale. For instance, if a business reports that it achieved 35 percent profit margin during the last quarter, it means that it had a net income of $0.35 for each dollar of sales generated.
Types Of Profit Margins
NET PROFIT MARGIN
There are several types of profit margin but the most common one usually refers to net profit margin. This shows exactly how much a business has made after all expenses have been subtracted from the revenue.
When calculating new profit margin remember that net profit and net income are used interchangeably as is sales and revenue. Expenses to subtract may fluctuate between raw materials, operations, labor, rentals, interest payments, and taxes.
PRETAX PROFIT MARGIN
Pretax profit margin is your earnings before taxes then divided by revenue. Take your operating income and deduct any interest expense while adding any interest income. Adjust any kind of non-recurring expenses such as gains or losses from discontinued operations and you will have your pre-tax profit.
OPERATING PROFIT MARGIN
This can also be known as a company’s earnings before interest and taxes. Usually this operating profit margin is used on any kind of unsettling debt or to equity holders. This is also used by bankers and analysts to accurately measure a company’s value for buyouts.
How Do I Use It?
Whether operating a billion dollar company or a mom and pop shop, profit margin has transitioned into the universal standard measure of how well a company or business is doing and the amount of potential it has to grow.
Profit margins keep companies and businesses in check in order to continue to grow or diagnose the lack of growth.
A positive or negative profit margin shows you how well you are managing costs, sales, and growth. Profit margins are typically the first thing done when quarterly reports are conducted. These reports help any arising issues such as unsold inventory, underutilized resources, or unnecessary high costs. From there you step forward to devise a plan of action to assess what is and what isn’t working.
Profit margins are also useful when a business seeks out for funding. With reliable and accurate reports of profit margin, you are that much more inclined to receiving a loan from banks and other lenders
Finally profit margins are significant for investors before making their decision to give you funding. If you are a startup company and provide these kind of profit margins that literally show the potential of your operations than investors are going to feel a lot more safer to go all in with you.
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