Profit relative to revenue
Profit relative to revenue
In accounting and finance, a profit margin is a measure of a company’s earnings (or profits) relative to its revenue. The two main types of profit margins are gross profit margin (gross profit divided by revenue) and net profit margin (net income divided by revenue). This guide will cover the formula, examples, and even provide an Excel template you can use to calculate the numbers on your own.
When assessing the profitability of a company, there are two primary margin ratios to consider: gross and net. Below is a breakdown of each profit margin formula.
Gross Profit Margin = Gross Profit / Revenue x 100
Net Profit Margin = Net Income / Revenue x 100
As you can see, the difference between gross vs net is quite large. In 2018 the gross margin is 62%, which is the result of $50,907 divided into $82,108. The net margin, by contrast, is only 14.8% which is the result of $12,124 of net income divided into $82,108 of revenue.
Let’s consider an example and use the two formulas displayed above. XYZ Company is in the online retail business and sells custom printed t-shirts. The revenue from selling shirts in 2018 is $700k, the cost of goods sold (the direct cost of producing the shirts) is $200k, and all other operating expenses (such as selling, general, administrative (SG&A), interest and taxes) are $400k. Calculate the gross and net profit margins for XYZ Company in 2018.
($200,000) cost of goods sold
$500,000 gross profit
($400,000) other expenses
$100,000 net income
Based on the above income statement figures, the answers are:
Gross margin is equal to $500k of gross profit divided by $700k of revenue, which equals 71.4%.
Net margin is $100k of net income divided by $700k or revenue, which equals 14.3%.
You may be asking yourself, “what is a good profit margin?” A good margin will vary by industry, but as a general rule of thumb, a 10% net profit margin is considered average, a 20% margin is considered high (or “good”), and a 5% margin is low. Of course, these guidelines can vary widely by industry, company size, and a variety of other factors.
Below is a screenshot of CFI’s profit margin Excel calculator. As you can see from the image, the Excel file allows you to input various assumptions over a five year period. All cells with blue font and light grey shading can be used to enter your own numbers. All cells with black font are formulas and don’t need to be edited.
As you can see the screenshot, if you enter a company’s revenue, cost of goods sold, and other operating expenses you will automatically get margins for Gross Profit, EBITDA, and Net Profit.
To edit the Excel calculator you can insert or delete rows as necessary, based on the information you have. For example, to add more expense line items like ‘Salaries and Wages’, simply insert a row for each one and add the numbers as appropriate.
Enter your name and email in the form below and download the free template now!
Whan analyzing a company a good analyst will look at a wide range of ratio, metrics, and other measures of performance. Below is a list of common metrics an analyst should consider in order to complete a fulsome analysis of a business.
Additional performance metrics include:
By considering the above factors (and more) with the profitability margins covered in this article you’ll be well on your way to performing a complete analysis.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, these additional resources will be useful:
Learn accounting fundamentals and how to read financial statements with CFI's free online accounting classes. These courses will give the confidence you need to perform world-class financial analyst work. Start now!
Building confidence in your accounting skills is easy with CFI courses! Enroll now for FREE to start advancing your career!