Profitability metrics is crucial to business operations. Therefore, businesses will often use a profit margin calculator to ensure their revenue performance is adequate.
Profitability calculations play an important role in strategy as they identify pressure points in the operational framework. In addition, they allow shareholders to measure the company’s investment potential. Together, these metrics can enable leadership and investors to see how the company performs compared to its competitors. This article takes a closer look at the different types of profit and investigates the importance of accurate profit margin forecasting.
Not all profits are created equal
According to the Oxford English Dictionary, profit is “a financial gain, especially the difference between the amount earned and the amount spent in buying, operating, or producing something.” Although every business professional is aware of the significance of profit, it is useful to drill down into the three main categories that appear on a company's income statement.
Gross profit is revenue minus production overheads. In accounting, the gross profit is the amount of money a business takes before deducting operating expenses, tax, and borrowing interest repayments and fees. Therefore, gross profit is the revenue that remains after accounting for the cost of goods sold (COGS). COGS only include expenses directly associated with the manufacture of an item, including raw materials and labor. Gross profit is the most simple profitability metric, as it reflects the proportion of revenue retained against production.
Operating profit is the money that remains after deducting operations overheads from gross profit. Generally, operating overheads include sales and administrative expenses. Although this figure still does not include tax and interest, it does include depreciation and amortization. With this figure, businesses can calculate a mid-level profitability margin that expresses the portion of monies remaining after all business expenses.
Net profit – or the bottom line – is the amount of money that remains after deducting all overheads including taxes and debt expenses from the company’s revenue. Essentially, net profit is the amount of money a company earns after all costs.
The difference between margins and profits
Profit margin is probably the most common expression in corporate accounting. As discussed above, business profits are expressed across three levels, with gross profit being the most basic and net profit the most comprehensive. As such, the gross profit margin is an indicator of a business’s overall performance, illustrating whether or not a company is using an appropriate pricing strategy. To calculate the gross profit margin, deduct production overheads from net sales. Next, divide the result by net sales to determine the ratio that expresses the gross profit margin.
In contrast, the net profit margin determines the business’s capacity to transform revenue into profit. To find the net profit, divide net income by total sales. The result is then multiplied by 100 to express this value as a percentage. This calculation will illustrate the company’s profitability and growth. If the calculation shows that profit margins are low, then the management will have to reconsider their strategy.
The benefits of a profit margin calculator
Calculating profit margins are crucial to business strategy. As a key indicator of a business’s profitability, it is essential for the business owners to clearly understand this metrics to optimize strategy. Furthermore, considering the intensity of today’s markets, profit margins are essential to understanding how a business is performing against competitors. Now, businesses can access an online profit margin calculator that simplifies this process. With the help of a profit margin calculator, businesses can ensure their operations and pricing strategies are delivering the desired results.