What is profit margin? How to calculate different types of profit today

What is profit margin ? What does this index mean for business operations? In the article below, let's learn in detail about the concept, meaning and how to calculate profit margin quickly and accurately with 1C Vietnam.

1. What is profit margin?

Profit margin is an important financial indicator in accounting and corporate finance, representing the ratio of profit to revenue or sales of a company. Profit margin is calculated by dividing net profit by revenue or sales, after deducting all costs associated with running the business.

Profit margin is usually expressed as a percentage and helps measure a business's ability to generate profits from operations. This is an important tool to evaluate a business's financial performance and compare it with other companies in the same industry or over different periods of time. A high profit margin is often considered a good sign because it shows that a company can make a profit from its business operations. However, profit margin must be considered along with other factors such as company size, industry, and specific market.

2. Meaning of profit margin

After understanding what profit margin is , businesses also need to understand the meaning of profit margin.

When evaluating a company's performance, the focus is often on total revenue, net profit or business expenses. However, these numbers do not help identify the core issues, the nature of the business's performance and operating capabilities.

Instead, profit margin is a standard measure to evaluate the potential and profitability of a business. Specifically:

• If the profit margin is high, it proves that the company's management operations are stable and profitable. In addition, high profit margins mean low commission rates, which shows that the business is managing costs well and optimizing its operating budget.
• If the profit margin is low for a company it means that the company makes little profit, low profitability. This may be because the company sells the product at a lower price or because the product price (production cost) is higher than the market.

3. Classification and calculation of profit margin

Profit margin is divided into three categories: Gross profit margin, net profit margin and operating profit margin. Each type of profit margin has a different calculation method as follows:

3.1. Gross profit margin

What is gross profit margin ? Gross profit margin is a measure that reflects the profit a company earns from sales costs and cost of goods sold. The efficiency of using labor and materials in the company's production and business process can be expressed by gross profit margin.

The formula for calculating profit margin that businesses can refer to is as follows:

Gross profit margin = (Revenue – Cost of goods sold)/Revenue

For example: The revenue of enterprise X is 890 million VND. Cost of goods sold includes the cost of purchasing raw materials and labor costs of 200 million VND. Thus, gross profit margin = (890,000,000 – 200,000,000)/890,000,000 ≈ 77.5%.

When gross profit margin is high, the company has a cash surplus. Businesses can use this excess money for many different business development purposes including expanding business scope, reinvestment, product development,...

In addition, gross profit margin will decrease if cost of goods sold increases. Therefore, businesses need to have appropriate spending policies to maintain a stable gross profit margin.

3.2. Net profit margin

Net profit margin is calculated based on after-tax profits earned from production and business activities. This indicator shows the relationship between net profit and revenue.

Different from the gross profit margin calculation formula, the net profit margin calculation is as follows:

Net profit margin = Net profit after tax/Revenue

For example: Company A's net profit after tax is 70 million VND, revenue is 330 million VND, net profit margin = 70,000,000/330,000,000 = 21.2%.

3.3. Operating profit margin

Operating profit margin is the activity of comparing profit before interest and taxes with sales revenue. This index allows businesses to self-assess their effectiveness in managing and generating revenue from production and business activities.

The formula for calculating operating profit margin is as follows:

Operating profit margin = Pre-tax revenue/Revenue

For example: A company has pre-tax profit of 650 million VND and revenue of 900 million VND, then operating profit margin = 650,000,000/900,000,000= 72.2%.

Hopefully this article from 1C Vietnam has helped businesses better understand what profit margin is as well as how to accurately calculate each specific profit margin. Don't forget to follow other useful articles on 1C Vietnam's website to update information on operations management in businesses.