Profit Vs. Profit Margin

Your business can show a profit without being profitable. When you end a quarter with a profit, your company made more than you spent. However, that doesn't mean you're earning enough to survive for the long haul. The difference between profit and margin is that profit margin gives you a better idea of your financial strength than profit alone.

Compared to some of the financial formulas out there, profit is simple to calculate. Take your total sales revenue for the month, quarter or year under discussion. Subtract total expenses. What's left is net profit.

For example, suppose your fashion boutique sold $157,000 in designer clothes over the past quarter. Your total expenses for the quarter are $130,000. Your net profit for the quarter is $27,000.

This is the calculation you make on your income statement for every reporting period. You start with total revenue, then subtract the cost of goods sold to get gross profit. When you subtract all your other expenses, you end up with net earnings or net profits.

When you calculate a net profit it shows that your business is running in the black, but it doesn't tell you whether you're earning enough return on your expenses to stay in business for the long haul. To figure that out, you need to know the profitability.

There are several methods for calculating profitability: Profit margin is one of them. To calculate profit margin, take your net profit and divide it by total sales revenue to get a percentage.

For example, suppose your computer repair service generated $22,000 in revenue over the past month. Expenses were $18,000, which results in a net profit of $4,000. Divide the $4,000 of profit by $22,000 in income to get a profit margin of 18%.

Profit margin is one of the key performance indicators. The importance of profit margin is that it shows how much return you get from the money you're spending. It's also useful for comparing the profitability of different companies with different levels of sales and profit.

Suppose your small startup with $25,000 in sales a month has $20,000 in expenses, giving you net profits of $5,000 and a profit margin of 20%. An established company in your field generates $120,000 in revenue a month, with $20,000 in net profits. That company has a profit margin of 16%.

What that tells you is that your company is the more profitable company. Your company's total revenue and net earnings are smaller than those of the larger company, but you're getting a higher return on your spending.

One difference between profit and margin is that even if your profits are substantial, your company's profit margin may be slim. That's not good, as the profit margin is a better indicator than net earnings of your long-term viability.

This is because all sorts of unexpected developments could cut into your profits. Insurance, rent or supply costs could go up. Sales could dip as consumer taste changes. Expanding your product line could increase your spending without boosting profits much, at least at first.

If you have a good profit margin, you're better equipped to ride out the inevitable fluctuations in expenses and income.

There are two ways to increase your profit margin. You can reduce costs or increase revenue. Raising prices comes with risks because your customers may not want to pay a higher price. If you find ways to reduce expenses, you can increase your profit and profit margin without driving customers away.