What is Profit Margin?

Definition:

Profit margin measures how many cents of profit a company keeps for every dollar it spends.

🤔 Understanding profit margin

It can be tough to get a good picture of how much money a company actually makes. It may pull in a certain amount each year, but that doesn’t take into account what it spends on paying employees, paying taxes, and producing whatever it’s selling. A profit margin is one way to calculate what a company really makes at the end of the day. There are different types of profit margins, but the one used most often is the most comprehensive: net profit margin. This is calculated by taking the company’s net profit (total revenue minus total expenses) ) and dividing that by total revenue. The result – in percentage form — tells you how profitable the company was over a period of time.

Example

Let’s look at the profit margin for Apple in the third fiscal quarter of 2019. Apple’s net sales were $53.8B. Its net income, meaning all the money it took in minus things like its fancy glass-box stores, slick advertisements, and factories in China, was $10.04B. To calculate net profit margin, we would divide that net income by total net sales, then turn that into a percentage by multiplying by 100:

Net profit margin = $10,044M ÷ $53,809M x 100 = 18.66%.

For every dollar Apple put out into the world, it got back a bit more than 18 cents in profit.

Source: Apple Condensed Consolidated Statement of Operations

Takeaway

Calculating profit margin is like taking a snapshot of a company...

It’s a single number representing how well the company is doing considering both what it makes and what it spends. If one company takes in $2M a year and another $1M, but the first company’s expenses are much higher than the second, then its profit, and therefore its profit margin, should be lower.

Ready to start investing?
Sign up for Robinhood and get stock on us.Certain limitations apply

New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.

Tell me more…

What is profit margin?

Let’s go back to that lemonade stand you set up in your parents’ driveway as a kid. You may have been doing it for fun, but maybe your neighbor jokingly asked if he should invest in your business. You could easily have told him whether it was a good investment by calculating your profit margin. You’d start with all the money you’d earned selling lemonade, then subtract the money you spent on ingredients and supplies: lemons, sugar, water, cups, a table and chairs, and even the crayons you used to make a sign. Then you’d divide the result by all the money you earned. If you made $100 by selling 100 cups of lemonade at $1 per cup, and all your ingredients and supplies cost you $40, then your net profit margin is 60% ($100-$40 = $60, and 60/100 = .60 or 60%). Your neighbor would be impressed!

What is a good profit margin?

You may assume that a good profit margin is a very high number, but even the most successful companies aren’t as lucky as that lemonade stand. Most companies don’t clock in much more than 20%. That’s because operating expenses are so high for many businesses. These include things like taxes, employee compensation, fancy offices, and stores that will attract customers. Generally, a 10% net profit margin is considered okay, and anything below that could use improvement. Meanwhile, 20% is considered quite good, and anything higher is great.

What are the different types of profit margins?

While net profit margin is the big one – the number that puts a stamp on the company that says “you’re doing well” or “you could do better” and the one most people think of when they hear the term “bottom line,” there are other types of profit margins that companies use to calculate how well they are doing or how well a specific product or service is doing. These can be just as important for investors evaluating a company, whether they’re Silicon Valley titans offering early seed money or stockholders looking to buy and sell.

Gross profit margin is a way of zeroing in on a specific product and figuring out how successful it’s been for the company. This number takes into account not only the price of the product, but also the “cost of goods sold,” or the direct cost of making the product. Going back to the Apple example, this would be the cost of creating a specific iPhone – materials, labor, and software development – subtracted from the amount of money Apple makes from selling that iPhone, then divided by that revenue and multiplied by 100.

Operating profit margin is more helpful to a company — or to bankers or analysts considering it for a buyout — than it is to the average consumer or investors. It represents the amount of money left over once the company subtracts operating expenses, but before it pays interest and taxes. This number gives company leaders a solid picture of where the company stands and what it can afford in the future.

How do you calculate profit margin?

To calculate each type of profit margin, you have to plug slightly different numbers into a fairly straightforward equation. Most of the time, you can obtain these numbers from a company’s income statement, which is a financial document highlighting a company’s profit over a set period of time.

As in both the Apple and lemonade stand examples above, this equation is roughly:

Profit/Revenue = Profit Margin x 100 = Profit Margin Ratio

Profit is the money a company generates, minus its expenses, whereas revenue is the money the company generates, period. If a company spends more than it generates, that top number (profit) will be negative, making the profit margin ratio negative as well.

You can find easy-to-use profit margin calculators online.

What are some industries with high and low profit margins?

To achieve a high profit margin, your company has to sell goods for more money than it takes to produce them. Unsurprisingly, luxury goods industries like fashion, fine watchmakers or jewelers, or software companies, often have high profit margins. It doesn’t hurt that their products can sit in the store for as long as it takes to sell them — They never have to throw anything out, because nothing goes bad.

Low profit margin industries are often those that sell perishable items that cannot sit on shelves for more than a few days, like grocery stores or specialty food shops. Airlines also have very high overhead (fuel, airport fees, the sheer cost of making and maintaining an aircraft) and consequently, lower profit margins.

Ready to start investing?
Sign up for Robinhood and get stock on us.Certain limitations apply

New customers need to sign up, get approved, and link their bank account. The cash value of the stock rewards may not be withdrawn for 30 days after the reward is claimed. Stock rewards not claimed within 60 days may expire. See full terms and conditions at rbnhd.co/freestock. Securities trading is offered through Robinhood Financial LLC.

1048612

Related Articles

You May Also Like

PARTICIPATION IS POWER™

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Options trading entails significant risk and is not appropriate for all customers. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.

Commission-free trading of stocks, ETFs and options refers to $0 commissions for Robinhood Financial self-directed individual cash or margin brokerage accounts that trade U.S. listed securities and certain OTC securities electronically. Keep in mind, other fees such as trading (non-commission) fees, Gold subscription fees, wire transfer fees, and paper statement fees may apply to your brokerage account. Check out Robinhood Financial’s Fee Schedule for details.

Brokerage services are offered through Robinhood Financial LLC, (RHF) a registered broker dealer (member SIPC) and clearing services through Robinhood Securities, LLC, (RHS) a registered broker dealer (member SIPC). Cryptocurrency services are offered through Robinhood Crypto, LLC (RHC) (NMLS ID: 1702840). Robinhood Crypto is licensed to engage in virtual currency business activity by the New York State Department of Financial Services. The Robinhood spending account is offered through Robinhood Money, LLC (RHY) (NMLS ID: 1990968), a licensed money transmitter. A list of our licenses has more information. The Robinhood Cash Card is a prepaid card issued by Sutton Bank, Member FDIC, pursuant to a license from Mastercard®. Mastercard and the circles design are registered trademarks of Mastercard International Incorporated. RHF, RHY, RHC and RHS are affiliated entities and wholly owned subsidiaries of Robinhood Markets, Inc. RHF, RHY, RHC and RHS are not banks. Products offered by RHF are not FDIC insured and involve risk, including possible loss of principal. RHC is not a member of FINRA and accounts are not FDIC insured or protected by SIPC. RHY is not a member of FINRA, and products are not subject to SIPC protection, but funds held in the Robinhood spending account and Robinhood Cash Card account may be eligible for FDIC pass-through insurance (review the Robinhood Cash Card Agreement and the Robinhood Spending Account Agreement).

2784249

© 2024 Robinhood. All rights reserved.
Follow us on

This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns. Before making decisions with legal, tax, or accounting effects, you should consult appropriate professionals. Information is from sources deemed reliable on the date of publication, but Robinhood does not guarantee its accuracy.

Options trading entails significant risk and is not appropriate for all customers. Customers must read and understand the Characteristics and Risks of Standardized Options before engaging in any options trading strategies. Options transactions are often complex and may involve the potential of losing the entire investment in a relatively short period of time. Certain complex options strategies carry additional risk, including the potential for losses that may exceed the original investment amount.

Commission-free trading of stocks, ETFs and options refers to $0 commissions for Robinhood Financial self-directed individual cash or margin brokerage accounts that trade U.S. listed securities and certain OTC securities electronically. Keep in mind, other fees such as trading (non-commission) fees, Gold subscription fees, wire transfer fees, and paper statement fees may apply to your brokerage account. Check out Robinhood Financial’s Fee Schedule for details.

Brokerage services are offered through Robinhood Financial LLC, (RHF) a registered broker dealer (member SIPC) and clearing services through Robinhood Securities, LLC, (RHS) a registered broker dealer (member SIPC). Cryptocurrency services are offered through Robinhood Crypto, LLC (RHC) (NMLS ID: 1702840). Robinhood Crypto is licensed to engage in virtual currency business activity by the New York State Department of Financial Services. The Robinhood spending account is offered through Robinhood Money, LLC (RHY) (NMLS ID: 1990968), a licensed money transmitter. A list of our licenses has more information. The Robinhood Cash Card is a prepaid card issued by Sutton Bank, Member FDIC, pursuant to a license from Mastercard®. Mastercard and the circles design are registered trademarks of Mastercard International Incorporated. RHF, RHY, RHC and RHS are affiliated entities and wholly owned subsidiaries of Robinhood Markets, Inc. RHF, RHY, RHC and RHS are not banks. Products offered by RHF are not FDIC insured and involve risk, including possible loss of principal. RHC is not a member of FINRA and accounts are not FDIC insured or protected by SIPC. RHY is not a member of FINRA, and products are not subject to SIPC protection, but funds held in the Robinhood spending account and Robinhood Cash Card account may be eligible for FDIC pass-through insurance (review the Robinhood Cash Card Agreement and the Robinhood Spending Account Agreement).

2784249

© 2024 Robinhood. All rights reserved.