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How Are Profit Margins Defined and Measured?What are profit margins and how do you measure them?As a business owner, your profit margins may be key to making money andgrowing a company. Evaluating your profit margins can assist you with gaugingthe financial health of your company. In order for your business to succeed,you may need to earn enough to turn a profit and reinvest into your company.This is where profit margins come into play.Profit Margins DefinedProfit margins measure profitability as a percentage on a company’s incomestatement. A larger percentage indicates better performance. Ideally, you wantrevenue much higher than expenses paid.For instance, a company with a profit margin of 20% is highly profitable. Acompany with a profit margin of 0.05% may need to make adjustments to improvetheir profitability. According to the American Enterprise Institute, theaverage profit margin for a U.S. company is 7.9%. However, that average mayvary across industries.What is Profit?Profit, also known as net income, is the money you make after deducting themoney you spent on business expenses. Many publicly traded companies calculateprofit quarterly basis and issue their earnings report after the quarterlycalculation is complete. That earnings report is a company’s benchmark forprofit and loss.Profit can indicate if a company is performing optimally. If profits are high,management may be doing a great job minimizing expenses. High profits couldalso point to marketing strategies that result in higher sales. If profits arelow or nonexistent, the company may be facing financial difficulty. There maybe weak demand as a result of management issues or poor sales techniques.What is Revenue?Profit measures the cash remaining after you pay your business expenses.Revenue is total business income before expenses, which is not an accuratemeasurement of a company’s performance.Having money coming in is great, but if you’re spending more than you’reearning, you may face financial difficulties.How to Measure Profit MarginsStory continuesWhat are profit margins and how do you measure them?Profit margins are measured by up to four calculations. Gross profit marginsand net profit margins are standard, but operating profit margin and pretaxprofit margin are factors as well.Gross Profit MarginAccountants use gross profit margins to determine if a business’s pricingstrategy is profitable. Dividing gross profit (revenue minus the cost ofproduction) by revenue earned can help a business adjust its pricing.Operating Profit MarginThe operating profit margin divides operating profit (revenue minus sales andadministrative expenses) by revenue, but leaves a few essential items out ofthe equation. While it includes operating costs and the costs of goods sold,it doesn’t account for financial costs like taxes.Pretax Profit MarginPretax margins simply divide pretax earnings by revenue. This can helpdetermine the impact of local and federal tax on your business’ bottom line.Net Profit MarginA company’s net profit margin measures its total profitability. A high netprofit margin is likely great news for a thriving company. A low net profitmargin can indicate issues including high costsNet profit margins measure the total profitability of a company. A high netprofit margin suggests the company is moving in the right direction. A low netprofit margin may indicate potential problems including high costs or weaksales.To calculate a net profit margin, divide the company’s net income into totalrevenue and then multiply by 100. For example:A company’s total revenue is $200,000The company’s total expenses are $160,000The company’s net profit is $40,000The total net profit margin is ($40,000/$200,000) x 100 = 20%Profit Margin in the MarketplaceLuxury cars and bespoke clothing have low sales, but high profits. High priceshelp, but companies and designers that only make products after takingcustomer orders reduce overhead.Meanwhile, if you run a delivery service or cab company that is affected bythe price of a gallon of gas, your margins are likely to be low. Thoughagriculture and automobile companies can succeed on a large scale, they oftendo so with low profit margins affected by multiple variables.While high profit margins can drive huge sales in software and patentedpharmaceuticals, low profit margins can drive companies straight out of acountry. Outsourcing to a less-expensive labor market might seem callous, butit can increase a company’s profit margin by reducing labor costs.Bottom Line What are profit margins and how do you measure them?It’s important to understand the impact profit margins have on your company’sperformance. f you want your company to prosper for years to come, perhapstake a close look at your profit margins and compare them to those of similarcompanies. This could allow you to make adjustments when necessary.Profit Tips * If you’re still having trouble with your profit margins, a financial professional who specializes in small business can help. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now. * In-depth budgeting is a worthwhile strategy to adopt if you’re looking to improve your long-term finances. It may, however, be difficult to build a budget if you have little to no experience doing so. To get some help, stop by SmartAsset’s budget calculator.Photo credit: ©iStock.com/iladendron, ©iStock.com/MicroStockHub,©iStock.com/RawpixelThe post How Are Profit Margins Defined and Measured? appeared first onSmartAsset Blog.#### Related Articles: