Margin (also known as profit margin) is a measure company’s profitability. It is calculated by dividing the company’s profit by its revenue and multiplying by 100 since the profit margin is always expressed as a percentage.
The profit margin also serves the role of an indicator for companies to see the efficiency of its pricing strategies and how well the company controls its costs. Depending on the type of business profit margin may vary according to the competitive strategy, as well as the product mix. For example, an investor made a 10$ by making a 1$ investment. In this case, the margin is 90%, which makes a 900% profit on the $1 investment.
Generally, there are three types of profit margins, which are used to evaluate one’s business performance. These are net profit margin, operating profit margin, and a gross profit margin.
Gross profit margin compares the company’s variable costs to its revenue. The gross margin aims to determine the value of additional sales and to guide the company’s decisions regarding their pricing and promotion strategies. It’s calculated with the next formula- (gross profits ÷ net sales) x 100; gross profits are the result of revenue minus the sum of direct materials, direct labor, and factory overhead combined; Net sales is the subtraction of cost of sales returns, allowances, and discounts from the revenue.
Operating profit margin includes costs of goods sold (or COGS), costs associated with selling and administration, and overhead. The operating profit margin is calculated using the following formula: (operating profits ÷ net sales) x 100. Operating profits are calculated by subtracting COGS, operating expenses, and other forms of expenses from the company’s revenue.
Net profit margin is the percentage of a business’s revenue after deducting all the expenses from it and the division of the result by the net sales. The formula looks as follows: (net income÷ net sales) x 100.
Profit margin is very important when doing business because if it’s not high enough, in comparison with similar businesses, investors won’t be interested in cooperation. Apart from that, profit margins drive companies to outsource employees from other countries in order to follow a budget-friendlier strategy. Last but not least is that profit margins help companies in developing pricing strategies for products and services they provide.
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