“It is a socialist idea that making profits is a vice. I consider the real vice is making losses.” – Winston Churchill.
If we omit every aspect of the business and try to find the only reason for any business to exist, then the answer is only one word: Profit.
In 1970, renowned economist Dr. Milton Friedman declared that any business’s sole purpose is to generate profits for its shareholders.
And he can’t be more right. Social welfare, employee welfare, and other expenses can only be done when the business is able to generate profits.
This is the reason that Profit Maximization is no more a ‘greed’ which some traditionalists want to argue, but Profit Maximization is the basic necessity for the business, a means to survive and thrive.
With this understanding, it becomes imperative for the entrepreneur to search and find a High-profit margin business, wherein they can generate maximum profit, at least risk.
In this blog, we will share easy ways to calculate profit for any business and explain How to calculate the profit margin for any business.
Besides, we will glimpse into the interpretation of net profit ratio and How to calculate net profit margin.
But before that, let’s understand what exactly is Profit, and why it’s important?
What Is Profit?
In accounting, profit is the owner’s income due to a profitable market production process. Or in layman’s terms, profit is the end result of a business process, wherein the owner creates some value and sells it to the buyers.
How To Calculate Profit Margin?
There are various ways to calculate profit margins, depending on the business’s nature and the entities involved.
But the three most common types of profits that a typical entrepreneur calculates are:
- Gross Profit Margin
- Operating Profit Margin
- Net Profit Margin
How To Calculate Gross Profit Margin
Gross Profit Margin is the simplest form of profit calculation, and it only considers the COGS or Cost of Goods Sold. Operating cost, taxes, interests, etc. are not calculated.
Thus, if we remove COGS from the net sales, then what remains is the gross profit margin.
Via formula, we can represent the Gross Profit Margin as:
How To Calculate Operating Profit Margin
Operating Profit margin is the next level of profit calculation, wherein the cost overheads such as operating cost, administrative costs, sales expenses, etc. are considered.
But still, debts and taxes are excluded from this calculation.
Via formula, we can represent the Operating Profit Margin as:
What is Net Profit Margin?
Net profit margin is the most practical and realistic form of profit calculation, being the next level of operating profit margin.
Net Profit Margin is always represented as a percentage or decimal point, and it’s described as a ratio of net profits to net revenues for any business. It takes into account COGS, operating expenses as well as debt and interests.
In layman’s terms, the net profit margin describes how much of the revenue collected by a business translates into profits.
If the net profit margin of a company is 0.56 or 56%, then it means that for every dollar or rupee generated in revenues, the business can generate 56 cents in profits.
How To Calculate Net Profit Margin?
The formula for calculating Net Profit Margin is:
(Net Profit/Net Revenue)*100
Now, to expand this formula and to derive the exact net profit margin, we include these elements for calculating net profit:
- The total cost of goods sold
- Operating and other expenses
If we include these factors, then the formula becomes:
Entrepreneurs and management teams of businesses, big or small, should be able to decode and interpret critical and vital metrics such as net profit margin, gross profit margin, and operating profit margin.
This enables them to better grip the finances and chalks out a blueprint for higher growth.
Net Profit Margin Interpretation: What Does It Tell You?
Let’s assume that there is a shoe retail shop, and these numbers were visible on their statements:
Operating costs: $10,000
COGS or cost of goods sold: $20,000
Tax liability: $7000
Net profits: $13,000
In this case, the net profit margin is (13,000/50,000)*100, which is 26% or 0.26.
This means for every 1 dollar of revenue generated, this shoe retail company is generating 26 cents of profit.
How Net Profit Margin Impacts Small Businesses?
Resources and finances limit most small businesses.
Since there are fewer employees, the delegation of every task is not possible, and the owner needs to carry most of the business activities.
Under these tight circumstances, it becomes crucial for small business to keep their net profit margins as high as possible so that they get maximum ROI, at minimum risk.
If you are planning to start a new business and research the market, then focusing on the Interpretation of net profit ratio (or net profit margin) makes sense.
High-profit margin business should be the focus, as it can assure higher returns in lesser time.
But how can you discover such a high-profit margin business, which can guarantee a high net profit margin? Where to find businesses which have fewer operating expenses and higher net profits? How can you lessen the tax impact on your operating income and ensure a high net profit margin, month after month?
This is where we, at MSMEx, can help you, instantly, and live.
MSMEx is a micro-advisory platform, which provides entrepreneurs, MSMEs, and startups with expert business advice at the tip of their fingers, literally.
With a few taps and clicks, you can discover the right business mentor, right business coach, and the right business guide, who can suggest you the best business advice, live and instantly.
All you need to do is book an appointment and take your business idea into a new journey of unprecedented growth.