How To Calculate Profit Margins

Overview

Nothing diagnoses a business’s health better than its profit margins!.

Therefore, calculating profit margins is the first step towards identifying different ways to elevate your business.

Wondering how you can calculate profit margins?

Here’s a step-by-step guide on How To Calculate Profit Margins, helping you unravel the financial secrets to calculating and, in turn, earning high profits!

Back To Basics

Profits are intuitive to understand since they are, quite simply, the leftover income a business has after accounting for all costs and expenses.

But let’s pause here for a second.

If profit calculations are so intuitive, what’s the point of learning a complex method of calculating profits?

For starters, calculating profit margins according to industry standards allows a more accurate calculation. It is essential to create transparency and increase the efficiency of a business.

Additionally, with our guide, you don’t have to worry about its difficulty or complexity!

What Is Net Profit Margin?

Net Profit Margin is the primary determinant of how profitable a business is. Thus, it is often called the bottom line.

Step-by-Step Guide to Calculate Net Profit Margin

Of course, knowing just what profit margins are and calculating them are completely different.

We help you achieve the latter with a simple guide:

·      Step 1: Calculate Net Sales

Calculating net sales is the first step to determining profit levels.

The difference between total revenue and returns, refunds, discounts, and cost of damaged goods gives a net sale value.

·      Step 2: Calculate The Net Income

Costs are a consequence of creating income.

However, since those costs are cash outflows – money leaving the firm – we have to remove the contribution of expenses to arrive at the net income amount.

Net income is straightforward: the difference between total revenue and expenses will give a net income value.

·      Step 3: Determine the Profit Margin Ratio

Having followed steps 1 and 2, you would arrive at two values: net sales and net income.

Dividing the net income amount by net sales would give a ratio of the profit margin.

When the ratio is calculated by 100, it gives a value in terms of percentage.

·      Step 4: Interpreting The Profit Margin Ratio

Since the value is a net income ratio to net sales, one arrives at a value that reflects how much revenue is generated by a certain number of sales.

Hence, it also measures how profitable the sales are and gives insights into a product’s profitability.

Other Types Of Profit Margins

There are three types of profit margins.

• Net Profit Margin
• Gross Profit Margin
• Operating Profit Margin

While all profit margins calculate profits, each has a specific purpose.

Now that we have covered net profit margins, we could explore what gross profit and operating profit margins say about our business.

·      Gross Profit Margin

Gross Profit Margin considers profit by subtracting the contribution of Costs of Goods Sold (COGS).

It means how much it costs you to make a product versus its contribution to the overall profit.

While net profit margin allows us to determine the profitability of an overall business, gross profit margin could help us determine the profitability of a single product.

·      Operating Profit Margin

Every activity that is directly involved in making a product or service is categorized as an operational activity.

In operating profit margins, we consider the cost of goods sold and all the indirect and overhead expenses, such as costs arising from administrative, sales, and day-to-day operational activities.

Takeaway

Everyone loves profits!

But not everyone enjoys the unexciting process of calculating profits.

However, our simplified guide, and the following bonus tip, would make things a lot easier for your business.

For our bonus tip, we recommend using Microsoft Excel and its functions and formulas to automate the process of calculating profit margins.

As always, Four Seasons General Merchandise is readily available to help you in your product needs, whether it’s cookware, office supplies, kids toys, and much, much more. After being in this business for 37 years, we have acquired the knowledge, infrastructure, and team to successfully and efficiently cater to our client’s needs.

So, what are you waiting for?

Go and calculate profit margins with confidence and take the next step of building your career and business.