Understanding profit and profit margins are crucial to the ultimate goal of business owners and decision makers-to earn the money they need to be successful and to grow their company.
What is a Profit?
In one word, profit is the amount of money a company makes from the money it spends on the operation. Profit is the financial measure to measure the performance of a company. After every business expense is recorded over a specific period, it is the cash remaining.
What is the revenue?
Revenue is the amount of cash that a company takes during its business process. While revenue represents all income, profit is a key figure in a financial statement-it demonstrates what remains of the company after all its bills are settled. That is why revenues can not be used to measure financial performance correctly.
Profit Margin Formula
The formula for the profit margin is net income divided by net sales. Net sales include gross sales minus discounts, returns, and allowances. Net income is the total revenue minus expenses.
The profit margin is at the heart of your business’s success. It demonstrates the percentage of your revenue, as compared to company costs and expenses. Profit margins in business finance tell you how much you get on every product or service.
While it seems logical, small business owners either don’t understand or forget about profit margins, including what your profit margin objectives should be. You can use our useful guide to evaluate your small business ‘ good profit margin goals below.
Importance of Profit Margin
These are some reasons why your profit margins should be tracked:
- This helps you to grow your business: Figuring out profit margins can help you determine the excess cost or the performance of your business products and practices. It is useful to know how your business is progressing as it grows and expands.
- For financing, it is needed: You may have an impressive product, concept or service, but lenders would like to understand what your profit margin is before you offer small business credit. Although you make millions already, it is harder to secure financing if you don’t know if you aren’t rentable.
- It enables you to solve problems: Staying tuned to your profit margin enables you to identify problems that your company might be running. For example, you may have some pricing mistakes, cost management problems or accounting issues if your profit margin is small.
If you have a profit margin, you can see that you actually earn as much dollars as your company expenses are covered. You can also see from the profit margin if your item has been too costly or too low.
What Is the Profit Margin Formula?
Most organizations use the following formula in calculating a company’s profit margin:
Profit Margin = (Net Income/Net Sales) * 100
Net income is the total revenue minus business expenses. Net sales is gross sales minus discounts, allowances, and returns.