A Deep Dive into Profit Margins
As a business owner, a crucial part of the role is keeping an eye on key financial metrics — understanding and calculating profit margin is a great place to start.
If the money doesn’t keep flowing, you won’t be able to keep the doors open for long.
One element of keeping track of cash flow and profits is calculating margin, so let’s explore this idea in a little more detail.
What is a profit margin?
The profit margin is a percentage that measures an organisation’s profitability.
It gives you the amount out of every dollar of a sale that turns into profits and gets kept as earnings.
For example, if your company achieved a 25 percent profit margin, that means the net income is $0.25 for every dollar of sales generated.
This margin is what you get when you subtract expenses from revenue.
What are the different types of profit margins in business?
When someone refers to a margin in business, they typically mean an organisation’s bottom line. That is, the final figure after all other expenses, including taxes, have been subtracted from revenue. This is the ‘net margin’.
However, there are also three other types of profit margins you can calculate.
The gross profit margin is what you get once you take the direct costs of your product or service (the cost of goods sold, COGS) from sales revenue.
This figure is the simplest margin to determine.
If you produce multiple goods or services, you can average out the costs of creating each or calculate a separate, gross margin for each offering.
The gross profit number doesn’t include other expenses, though, so also consider operating profit margin.
This margin acknowledges operating costs, sales expenses, admin costs, asset depreciation, research and development, marketing charges, amortisation rates, and so on.
As the name implies, the operating margin lets you know how much of each dollar you have left in profit after all the operational costs to run your business get factored in.
Pre-tax profit margins are the leftover amounts you have after taking your operating margin and deducting things like debt, interest, and any other charges or inflows (for example, income from investments) that don’t relate to your venture’s main business.
Finally, as mentioned above, the net profit margin is the final amount after taxes get paid.
Net profit margin is the trickiest one to track since it involves so many different elements, but it’s the one that will give you the most significant insights into your company’s position.
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