Profit Margin Basics

Understanding gross and net profit margins

11/10/2016

Understanding Profit Margin

Profit isn’t the only valuable metric for evaluating and predicting the current and future success of your business, but it is undoubtedly one of the most important concepts for entrepreneurs to master. Calculating your profit margins and keeping track of any changes can help you spot potential problems and fine-tune your operations throughout the year, which can make it easier to maximize your revenue.
 
According to Investopedia.com, profit margin can be industry-specific due to the variance of economic factors, and as a result, some businesses can expect to have greater profit margins than others.
 
The two types of profit margins you may be interested in calculating and comparing to standards in your industry are gross profit margin and net profit margin.
 

Gross profit margin

Gross profit margin determines the profitability of individual products or services. It is determined by subtracting the cost of goods from revenue.
 
It is easy to see why business owners would be interested in making these calculations, since an unprofitable business can be turned upside-down by even one unsuccessful product. On the other hand, a successful business may discover that only a small percentage of its products are contributing to the profits, giving it the potential to become more profitable simply by cutting out the products that are not contributing to a great enough degree.
 
Per Investopia.com, gross profit margin is a means to determine overall profitability, but it is not necessarily as precise in that regard as net profit margin.
 

Net profit margin

Net profit margin helps your business gain a better understanding of how its overall expenses compare to its revenue and track how that relationship evolves over time.
According to Investopedia.com, net profit can be determined by subtracting every expense that a business incurs from the gross profit. According to Intuit QuickBooks, this should include everything from payroll and utilities to taxes and interest paid on existing debt.
 
Then you must collect data about all sources of revenue, making sure not to forget less obvious ones like transaction fees. When the calculations are complete, you will be armed with the information you need to start making assessments and creating strategies for moving forward.
 
Net profit margin is not just a more accurate way to determine where profits emanate, but it can also be a valuable tool for fine-tuning strategies to increase profitability. In order to use the power of net profit calculations to the fullest extent, it is critical to be thorough when gathering numbers and checking calculations. To ensure the necessary level of comprehensiveness, seek the help of your financial institution or adviser for assistance.
 
If your profit margin is good, then it may be time to put your dreams of growing your business into action. If your profit margin is not particularly great, however, you can try to improve it by decreasing expenses, which can be achieved by changing production schedules, renegotiating contracts with vendors and shifting employee schedules so that you are never overstaffed. You might also try increasing sales, but Investopedia.com noted that the nature of competitive markets can make this means less effective than reducing outgoing expenses.

If you have not calculated your profit margins lately, take the time to do so soon, establishing a benchmark that can help you determine your current level of success and make goals for the future.

Published by North Shore Bank. Includes copyrighted material of IMakeNews, Inc. and its suppliers. 
 

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