Profit Margin
Candlefocus EditorProfit margins differ between industries and business models, and benchmarking a company against its peers is a more accurate way to evaluate performance. By knowing its own margin, the company can set goals and adjust its strategy accordingly.
Profit margin is a key indicator of the general financial health of a business.It is preferred to other forms of measuring financial performance, such as a return of equity, as this system does not take into consideration any external factors or subsidies.
Variations on Profit Margin include: Gross Profit Margin and Operating Profit Margin. Gross Profit Margin, calculated by subtracting the cost of goods sold from total revenue before any expenses are accounted for, reflects the business’ profitability from its current sales. A low gross margin may indicate pricing problems or low efficiency, since the other expenses, including operating and non-operating expenses, have not been accounted for.
Operating Profit Margin reflects the company’s pre-tax earnings from its operations. It includes all business expenses from the cost of goods sold up until but not including depreciation, amortization and taxes. This margin typically focuses exclusively on the company’s core operations, and therefore is more meaningful as a comparison between companies.
It is also important to measure profitability in terms of cash flows rather than income. Cash flows measure the actual amount of money that is changing hands, and can reveal areas of problems or inefficiencies that margins cannot. Likewise, looking at gross margin in addition to net margin can better access trends in the pricing of the goods and services provided by the company.
In conclusion, profit margin is a critical metric that enables a company to track financial performance, evaluate pricing strategies and benchmark itself against similar companies in its industry. By being aware of different types of margins and adjusting its strategies accordingly, the company can strive to generate and maintain a healthy profit margin.