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What is Profit Margin?
Profit margin is a financial metric that shows the percentage of revenue a company retains as profit after accounting for costs and expenses.
Definition
Profit margin measures how much of each unit of revenue remains as profit, expressed as a percentage.
Key Takeaways
- Indicates profitability and cost efficiency.
- Used to compare performance across companies and industries.
- Different margins apply at different stages of the income statement.
Understanding Profit Margin
Profit margin helps businesses and investors understand how effectively a company converts revenue into profit. Higher margins generally indicate stronger pricing power, cost control, or operational efficiency.
Margins vary widely by industry. For example, software companies often have higher margins than retail businesses due to lower variable costs. Comparing margins is most meaningful among firms operating in the same sector.
Management teams track margins over time to assess the impact of pricing decisions, cost changes, and scale.
Formula (If Applicable)
Gross Profit Margin:
Gross Margin = (Revenue − Cost of Goods Sold) / Revenue
Operating Profit Margin:
Operating Margin = Operating Income / Revenue
Net Profit Margin:
Net Margin = Net Income / Revenue
Real-World Example
If a company earns $200,000 in revenue and reports net income of $30,000, its net profit margin is:
$30,000 ÷ $200,000 = 15%
This means the company keeps 15% of revenue as profit.
Importance in Business or Economics
Profit margin is central to performance analysis, pricing strategy, and investment decisions. Sustained margin improvement often signals competitive advantage, while shrinking margins may indicate rising costs or competitive pressure.
Types or Variations
Gross Margin: Profit after direct production costs.
Operating Margin: Profit from core operations.
Net Margin: Profit after all expenses and taxes.
Related Terms
- Revenue
- Cost of Goods Sold (COGS)
- Operating Income
Sources and Further Reading
- Investopedia — Profit Margin
- Corporate Finance Institute — Profit Margin Explained
- Harvard Business Review — Measuring Business Performance
Quick Reference
- Measures profitability as a percentage of revenue.
- Higher margins generally indicate stronger efficiency.
- Best compared within the same industry.
Frequently Asked Questions (FAQs)
What is a good profit margin?
It depends on the industry; what is strong in retail may be weak in software.
Can profit margins change quickly?
Yes. Pricing, cost shocks, or scale changes can significantly affect margins.
Why track multiple profit margins?
Different margins reveal profitability at different stages of operations.
