Profit Margin

Business, Legal & Accounting Glossary

Definition: Profit Margin


Profit Margin

Quick Summary of Profit Margin


Profit margin is earnings (or corporate profit) divided by sales (or revenue), expressed as a percentage.



Video Guide For Profit Margin




Full Definition of Profit Margin


Profit margin is shorthand for net profit margin, or earnings divided by sales.

Profit margin usually refers to net margin (that is, how much net income was generated per dollar of sales), but it can also refer to other levels of profit margin, that is operating profit or gross profit.

Industry Dependent

For investors, the profit margin of a company must always be looked at in terms of the company’s competitors. It does no good to look at Microsoft’s (MSFT) 29.3% profit margin and say that is “better” than Safeway’s (SWY) 2.1%. The companies operate in different industries and are not comparable. Much better to compare Safeway to Kroger (KR) — 1.7% –or Costco (COST) — 1.3% — or Whole Foods (WFMI) — 1.9%, all “grocers.” That’s a better comparison.

A high-profit margin compared to its peers implies a successful business well able to outdo its competitors. That can mean key technologies protected by patents or high market share. It can also imply unique raw materials positions that others cannot easily duplicate. These aspects make a business able to defend its profitability from competitors.

A lower profit margin than its competitors suggests a business having trouble differentiating itself or controlling its costs.

Overtime

Now profit margins should, ideally, grow over time as the company gets bigger — spreading its fixed costs over more revenue — or better manages its costs. To see if this is happening, you should look at the profit margin over several years. Looking at the different levels of profit margin (operating, etc.) can give you a sense of where costs are being controlled, too. Is it in materials? Then that should improve gross profit margin. Are salaries to upper management being cut (we can hope!)? Then that should improve the operating profit margin.

For cyclical businesses, such as steel manufacturers or automakers, profit margins go up and down with the cycle of their business, even becoming negative at the bottom of the cycle. So for these types of businesses, looking at several years’ worth of numbers is also necessary. Nay, required!

Thus if a company sells $100,000 in merchandise and has earnings of $12,000, its profit margin is 12%. As a general rule, an improving (ie, a higher) profit margin is a favourable sign. But note that the profit margin is only one element in measuring a company’s ability to generate profits. For example, a company may maintain a high-profit margin, but only by keeping prices high, thus reducing sales. By lowering prices and sacrificing some profit margin, the company may be able to increase sales sufficiently to more than offset the reduced profit margin. On the other hand, if a company can maintain the same level of sales while cutting the cost of goods sold, SG&A expense, or taxes, it can increase its profit margin and raise total earnings as well. Because a gross profit margin, operating profit margin, and pretax profit margin are commonly computed for a company, it’s better to avoid ambiguity and not use “profit margin” when “net profit margin” is meant.


Related Phrases


Corporate profit
Cyclical
Earnings
Margin
Market share
Revenue


Cite Term


To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.

Page URL
https://payrollheaven.com/define/profit-margin/
Modern Language Association (MLA):
Profit Margin. PayrollHeaven.com. Payroll & Accounting Heaven Ltd.
March 29, 2024 https://payrollheaven.com/define/profit-margin/.
Chicago Manual of Style (CMS):
Profit Margin. PayrollHeaven.com. Payroll & Accounting Heaven Ltd.
https://payrollheaven.com/define/profit-margin/ (accessed: March 29, 2024).
American Psychological Association (APA):
Profit Margin. PayrollHeaven.com. Retrieved March 29, 2024
, from PayrollHeaven.com website: https://payrollheaven.com/define/profit-margin/

Definition Sources


Definitions for Profit Margin are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 29th November, 2021 | 0 Views.