Ratios: Profit Margin - Video Tutorials & Practice Problems

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Ratios: Profit Margin

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Alright, let's discuss another ratio here. The profit margin. So the profit margin. Well, we're talking about profit here, right? So in this case we're talking about our net income and we're trying to think of for each dollar of sales, how much net income do we get? Right? So these are usually not very high percentages because we have to pay for a lot of expenses, but the higher the percentage you can imagine, the better it is for the company. So the profit margin ratio, Well, it's a common profitability ratio, right? It's gonna give us information about how profitable the company is. So it's a profitability ratio. And when we talk about profit margin, that's always going to be a discussion about net income, Alright, these words are generally interchangeable. In this case, we're talking about it as a ratio. So we're gonna be calculating a percentage here. Okay, so let's go ahead and see this profit margin ratio here. Okay, so profit margin, it is the net income divided by net sales. Right? And notice we're multiplying by 100 here. It's because we generally show this as a percentage, right? So we show this as a percentage. So that's why we're multiplying by 100. And how do we analyze this ratio? Well, it's kind of like I said before, right? We want to know this ratio tells us how much net income, so how much net income are we getting for each dollar of sales revenue. So if this comes out to be 5%, well then we know that for each dollar that we sell, we sell a dollars worth of stuff. Well, at the end of the day, we're keeping five cents, we pay for everything, we get five cents out of it. Cool. And that five cents is our net income. Cool. Alright, let's go on and think about the comparison here. So how do we compare? How do we use this ratio to see is this a good, is 5% good? Is this company doing good or bad? What we're gonna use benchmarking? Like we do with a lot of other ratios, we want to compare to our competitors and we want to compare to the industry average, right? We want to understand how we relate to other companies in our sector. So maybe we have 5% and our competitors have 4%, that's a good thing. Right? Maybe we have 5% and our competitors are able to make 10%,. Well, that's not as good. Right? So it's we're gonna compare across different competitors and across the industry. So, red flag, we might find with this ratio is how could we get a negative profit margin? Well, negative profit margin would be if we had a negative number in here, Right? And we couldn't have negative sales, right? We were selling stuff, we're not gonna have a negative amount of sales, but we could have negative income. Right? The income could be actually loss if the company had a net loss. Well, we could end up with a negative, we will end up with a negative profit margin. That means we sold a bunch of stuff, but everything that it cost us to sell it, the cost of goods sold rent, paying salaries, everything that it costs us depreciation. Well, we ended up with a negative amount of profit, so we would end up with a negative profit margin. Cool, So that's about it. This is a pretty simple ratio. Why don't we pause here and go straight into some practice? I think you'll be ready to start calculating some profit margins. Right? Let's do that now.

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Problem

Problem

If XYZ Company has net sales of $500,000 and net income of $25,000, the profit margin is:

A

5%

B

10%

C

90%

D

95%

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Problem

Problem

A company has income before taxes of $100,000. Net sales are $400,000 and gross profit is $300,000. What is the profit margin, assuming the company has a 40% tax rate?