Profit margin

Definition

Profit margin is a financial metric that shows the percentage of revenue that exceeds a company's costs. It measures how efficiently a company converts sales into net income.

5 Must Know Facts For Your Next Test

1. Profit margin is calculated by dividing net income by total revenue and multiplying by 100 to get a percentage.
2. There are different types of profit margins, including gross profit margin, operating profit margin, and net profit margin.
3. A higher profit margin indicates better financial health and operational efficiency.
4. Profit margins can vary significantly between industries due to differences in cost structures and competitive environments.
5. The DuPont method breaks down return on equity (ROE) into three components: profit margin, asset turnover, and financial leverage.

Review Questions

• How do you calculate the net profit margin?
• What does a higher profit margin indicate about a company's financial health?
• Name the three components of the DuPont method.

Related terms

Gross Profit Margin: Calculated as (Revenue - Cost of Goods Sold) / Revenue x 100; it measures profitability before operating expenses.

Operating Profit Margin: Calculated as Operating Income / Revenue x 100; it indicates how well a company generates profits from its operations.

Return on Equity (ROE): A measure of financial performance calculated by dividing net income by shareholder's equity; it shows how effectively management is using a company’s assets to create profits.