A company’s profit margin is a company’s earnings for a specific time period, usually expressed in the form of a percentage. Calculating profit margin helps business owners and managers to understand how much money their company generates from operations. Different formulas exist for calculating profit margin. This allows companies to approach this information from a few different points of view to gain a full understanding of their operations. Profit margins formulas also provide owners and managers with a benchmark to compare against the industry average, helping them assess their company’s performance under current economic conditions.
Calculating profit margin falls under the profitability ratios common in the accounting profession. Accountants use a wide range of financial ratios to test a company’s information and determine a trend analysis to look for significant increases or decreases. The profit margin ratio has three particular formulas that provide information on different aspects of a company’s financial statements. The first two formulas — gross profit and net profit margin — takes information from the company’s income statement for calculating profit margin. The last formula, known as the return on assets, takes information from both the income statement and balance sheet to measure financial information.
The gross profit margin formula is gross profit divided by total sales. For example, a company with $175,000 US Dollars (USD) in total sales and gross profit of $40,000 USD will have a profit margin of 23 percent (40,000 / 175,000). Higher figures are preferable because this indicates that a company is generating more money from current sales. In this example, the company has $0.23 USD to pay for operating expenses with every $1 USD in sales.
An alternate formula for calculating profit margin is net profit divided by total sales. This figure is important because it takes into account the amount of money spent on operating expenses for the time period. Using the sales figure above ($175,000 USD), assume the company has $15,000 USD in net profit. The company’s profit margin is 9 percent (15,000 / 175,000). This indicates the company keeps $0.09 USD in profit for every $1 USD in sales.
A third method for calculating gross profit is to divide net profit before taxes by total assets. Assume a company has $17,000 USD in net profit before taxes and $375,000 in total assets listed on the balance sheet. The company’s gross profit is 5 percent (17,000 / 375,000). In short, this figure indicates the company will generate $0.05 USD for every $1 USD of total assets owned by the company.