How to conduct a profit margin analysis
Your company’s profitability plays a significant role in whether you succeed or fail
As a business owner, you want to make money. While your gross profits may look great, what happens when you factor in the many costs of doing business — product inventory, staff salaries, rent, deliveries and the like?
“Cash flow is critical for startups and small businesses,” said Edward Winkofsky, adjunct professor in UC’s Carl. H. Lindner College of Business. “It does not matter if you are making a profit unless you have the cash to sustain operations.”
A profit margin measures the percentage by which revenues exceed the costs of doing business. A profit margin analysis takes that a step further, analyzing the profitability of your business over time.
Calculating profit margin
You can easily calculate your company’s profit margin by finding your net income (gross income minus expenses), dividing that net income by your revenue, then multiplying the result by 100 to get a percentage.
Profit margins vary by industry. Be sure to compare your own margins against your peers for an accurate assessment.
To conduct a full profit margin analysis, start by tracking the three most important profitability ratios: gross profit (larger), operating profit and net profit (smaller).
- Gross profit margin (GP): This calculates the amount of money left over from product sales after subtracting the cost of goods sold (COGS). Also frequently expressed as a percentage of sales.
- Operating profit margin: Looks at earnings as a percentage of sales before interest expense and income taxes are deducted. Most businesses with high operating profit margins are more equipped to pay for fixed costs and interest on obligations, have greater chances to survive an economic slowdown and are more capable of offering lower prices than competitors with a lower profit margin.
- Net profit margin: It’s a financial ratio used to calculate the percentage of profit a company produces from its total revenue. Here, you measure the amount of net profit a company obtains per dollar of revenue gained.
What is net income versus profit? While both net income and net profit deal with an excess of income over expenses, their definitions differ in important ways. Net profit means revenue remaining after expenses. Net income is a single number representing a specific type of profit and is the renowned bottom line on a financial statement.
Featured image at top: Courtesy of Razvan Chisu, Unsplash
Help for small business entrepreneurs
Looking for advice? The University of Cincinnati’s Center for Entrepreneurship provides an array of services to entrepreneurs, managers and businesses, including a Small Business Institute consulting program.