Profit Margin

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DEFINITION of 'Profit Margin'

A ratio of profitability calculated as net income divided by revenues, or net profits divided by sales. It measures how much out of every dollar of sales a company actually keeps in earnings.

Profit margin is very useful when comparing companies in similar industries. A higher profit margin indicates a more profitable company that has better control over its costs compared to its competitors. Profit margin is displayed as a percentage; a 20\% profit margin, for example, means the company has a net income of $0.20 for each dollar of sales.

Also known as Net Profit Margin.

INVESTOPEDIA EXPLAINS 'Profit Margin'

Looking at the earnings of a company often doesn't tell the entire story. Increased earnings are good, but an increase does not mean that the profit margin of a company is improving. For instance, if a company has costs that have increased at a greater rate than sales, it leads to a lower profit margin. This is an indication that costs need to be under better control.

Imagine a company has a net income of $10 million from sales of $100 million, giving it a profit margin of 10% ($10 million/$100 million). If in the next year net income rises to $15 million on sales of $200 million, the company's profit margin would fall to 7.5%. So while the company increased its net income, it has done so with diminishing profit margins.

Things to remember
  • This ratio is not useful for companies losing money, since they have no profit.
  • A low profit margin can indicate pricing strategy and/or the impact competition has on margins.

To know more about profit margins, read A Look At Corporate Profit Margins and Profitability Indicator Ratios: Profit Margin Analysis.

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