I know that profit is what's left over after expenses have been deducted from all income and revenue.How do I get to the profit margin once I have the profit amount?
Profit margin is essentially a measure of profitability of a business by calculating the percentage of profit over the revenues or sales of that business during the period. It is a useful tool for management when looking at trends in the business. These trends could include comparisons between different products, trend analysis over a number of years, or comparisons with other companies and industry standards.
Profit margin is different to percentage markup or return. Profit margin can easily be confused with percentage return which works out the profit gained over the input costs expended. This is also useful in telling management what percentage profit they will gain from a particular investment.
Profit margin shows management the percentage of revenues that are retained by the business i.e. not used to cover expenses. These profits can be reinvested into the business leading to growth, or distributed to the owners through drawings (sole proprietorship) or dividends (private or public corporation).
Useful calculations include gross profit margin and net profit margin.
Gross profit = sales and/or services revenue less all costs involved in producing those sales (i.e. cost of goods sold)
AND Net profit = gross profit plus other income less operating expenses, interest expense and tax
A quick example below:
Henry's Carpet Cleaning Services provided services to the value of $109,500 over the year ended 30 June 2013. Cost of goods sold (COGS) amounted to $56,800. Henry also received interest income of $1,850 and had total operating expenses of $32,600 for the year.
Calculate: gross profit margin and net profit margin (assume a tax rate of 30%)
Gross profit = service revenue - COGS
= 109,500 - 56,800
EBIT (earnings before interest and tax) = gross profit + other income - operating expenses
= 52,700 + 1,850 - 32,600
Net profit = EBIT - tax
= 21,950 - (21,950 * 30%)
= 21,950 - 6,585
Gross profit margin = gross profit / revenue x 100
= 52,700 / 109,500 x 100
Net profit margin = net profit / revenue x 100
= 15,365 / 109,500 x 100