The profit margin ratio contrasts profit to sales and tells how effectively the company is managing its finances overall. It's always expressed in percentage. It is the ratio of a company's profit (sales minus all expenses) divided by its income or earnings. There are three types of profit margins namely gross profit margin, net profit margin, and operating profit margin.
TYPES OF PROFIT MARGINS
- GROSS PROFIT MARGIN- This ratio indicates the relationship between gross profit and net sales. The higher the ratio, the lower the cost of goods sold. Gross Profit is the total revenue excluding the cost of goods sold.
FORMULA: Gross Profit Margin = Gross Profit / Revenue x 100
- OPERATING PROFIT MARGIN- The objective of computing this ratio is to determine the operational efficiency of management. Operating Profit is the total revenue excluding the cost of goods sold and operating expenses.
FORMULA: Operating Profit / Revenue x 100
- NET PROFIT MARGIN- Net Profit Margin indicates the overall efficiency of the business. The higher the net profit ratio, the better the business. Net Profit is the total revenue excluding all expenses, interests, and taxes.
FORMULA: Net income/ Revenue x 100
WHAT IS A GOOD MARGIN PROFIT?
Profit margins differ from business to business and industry to industry. Going with the general guidelines, a 10% profit margin is looked at as a fair profit margin. The high-profit margin is 20% while 5% is considered a low-profit margin.
HOW TO INCREASE PROFIT MARGIN?
- Reduce operating costs-Merchants should always look for new and effective ways to reduce operating costs without compromising the quality of their products or making operations more difficult.
- Don’t obsess over per order profits- Instead of focusing on profit, provide the customer with the best of services. Solve problems, compensate the customers if they are disappointed. Satisfied customers refer brands among their peers if they are pleased. This helps create a customer base and retains customers.
- Increase the trustworthiness to generate sales- Building trust between you and a first-time shopper encourages them to make frequent purchases from your business. This increases profit margins in the long run. To strengthen trust, a loyalty program can be set up wherein customers are given points to make them come back.
- Raise your prices- You may try increasing the prices if you think your product has some unique features which make it stand apart from the existing products. If the customers are cost-conscious, this strategy won’t work well