Today, in order for businesses and companies to properly assess the current direction of the business, people often use a quantity in economics that is profit margin. (or profit margin, marginal profit – literally translated as profit margin).
However, many people do not really understand this concept. So What is profit margin?? What does it mean? How to calculate Profit Margin? Follow the article to get the most useful information.
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What is Profit Margin?
English profit margin is Profit Margin.
Profit margin, net margin, net profit margin or net profit ratio is a measure of profitability. It is calculated by finding the net profit as a percentage of the revenue – According to Wikipedia
Profit margin cis the ratio received by dividing net income or profit by total sales. Because of this calculation, profit margin can be called by many different names such as profit margin or net profit.
The profit margin is calculated as a percentage, that is, divide the net profit by the total revenue, and then multiply this number by 100 to get the percentage.
To evaluate Profit Margin, businesses often consider the following two profit margins:
- Gross profit margin.
- Net profit margin
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Features of profit margin (Profit Margin)
Compared to average profit and net profit, Profit Margin tells us how much money is generated at the end of the process of producing one more product. Therefore, profit margin directly affects the scale of production. As the Business grows stronger, the profit may increase or decrease depending on the cost structure and the size of the Economy at that time.
Profit margin is applied mainly for internal comparison because it is difficult to use profit margin when comparing the net profit of different entities. It doesn't make much sense to compare profit margins between different companies, and the operating and financial processes of each company are different.
Profit margin is an indicator of a company's pricing strategy and how well it controls costs. Differences in competitive strategies and product mix cause profit margins to vary between different companies.
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The most correct formula for calculating profit margin
Gross profit margin (Gross Profit Margin)
Gross profit margin often applies to a specific product rather than to an entire Business. From this number, the operating department of the business can set, adjust prices or use it to negotiate with raw material suppliers.
Gross profit margin is calculated using the same formula as normal profit margin, only applicable to a specific product line:
- Gross profit margin = Revenue (tax excluded) – Cost of raw materials (tax excluded)
- Gross Margin = (Gross Profit / Sales) x 100%
For example: Company A sells $16,000 in total sales and costs $12,000 in total
- Gross profit margin = 16000 – 12000 = 4000 USD.
- Gross Margin = (4000/16000) x 100 = 25%.
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Net profit margin (Net Profit Margin)
Compared to gross profit margin, net profit margin is a more comprehensive number when it helps to determine the profit or profitability of the entire business. The metrics that are included in the calculation will be the overall revenue and production costs of the business as a whole, rather than just a specific item.
The formula for calculating net profit margin is as follows:
Net profit margin = Profit after tax / Sales
For example: Total revenue of company B is 150,000 USD, expenses are 75,000 USD, net profit margin is 75,000 USD
Marginal net profit = (75,000/150,000) x 100 = 50%.
The higher the net profit margin, the higher the rate of return, the lower the risk. On the contrary, the lower the net profit margin, the more it shows that the enterprise needs to reconsider the cost of raw materials, production lines, transportation, distribution, ... and must find ways to optimize profit margins to reduce risks. ro.
In some cases where we see a decrease in net profit margin, this is because the increase in profit after tax is less than the growth in sales.
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Operating Profit Margin
Operating profit margin is a metric used to compare earnings before interest and taxes with sales. Based on this index, enterprises can make their own judgments about the effectiveness in managing revenue generation from production and business activities of that enterprise.
Operating profit margin is calculated using the following formula:
Operating profit margin = EBIT (Earnings before tax)/Sales
What is the meaning of Profit Margin?
The profit margin results you get will indicate the profitability of the product, because the larger the margin, the higher the profit this product will bring.
Low profit margin also means that the margin of safety is low, ie the profit that this product brings is not guaranteed, leading to a risk that sales will follow that trend and decrease, leading to The profit may not be enough to cover the loss.
The profit margin can also be understood as the difference between the selling price and the total cost for it. Therefore, this ratio is usually only used for internal comparison, because only the business that is selling the product knows the cost of production and consumption of the product, or in other words, the revenue of the product. there.
Profit margin will be different for businesses of different sizes, orientations and strategies, so comparing profit margins between two businesses is quite lame and does not help to make a useful comment. .
- If the Investor earns $10 in revenue and loses $1 in expenses, after he deducts expenses, he will be left with $9. That is, he made a 90% return on an investment of only 1 USD.
- If an investor earns 10 USD and loses 5 USD in investment costs, after deducting he will gain 50%. That means he made 50% of his initial 5 USD investment.
- If an investor earns 10 USD and loses 9 USD in investment costs, after subtracting he will gain 10%. That means he made 1 USD from his initial 9 USD investment
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What businesses should note about profit margin (Profit Margin)
As mentioned in the characteristics section, profit margin only evaluates the level of profitability when completing a product, not the overall profit of the enterprise. Therefore, as soon as the profit measurement of a product after being born reduces the overall profit, it means that this product is no longer guaranteed to be effective in business and should be discontinued.
Factors affecting the profit margin of a product can be mentioned as:
- Cost of supplies or materials
- Interest incurred
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With the information shared in this article, hopefully those who are interested will have the most comprehensive view of profit margin. Let's immediately grasp the most basic knowledge to be able to correctly answer questions such as: What is profit margin?? What does profit margin mean?
In particular, with the parameters brought from the profit margin calculation, your business and company can offer the most suitable plans to develop them.
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