Margin vs Profit: Why You Need to Track Profit Margins

Margin vs Profit

While gauging the performance of a corporate business or publicly listed companies, different types of indicators are used by financial analysts. Various Key Performance Indicators (KPIs) are calculated to measure a company’s financial health. For example, liquidity and margin vs profit are the most commonly used measures to analyse the profitability of a business.

Similarly, the small and medium-sized also scrutinise these measures to gauge the performance of their businesses. However, the absolute numbers do not provide a complete picture of a business. For this, the business owners have to look at a broader perspective to make wiser and more intelligent business decisions.

This blog will discuss the most widely used measure of profit margins and profit. Which one is best while looking at the performance of a business? And, how to calculate the profit margins? So, let’s start!

 

Margin vs Profit

Profit is a whole number, telling you about a company’s revenue. Profit is calculated after the costs are deducted from the total revenue. If you look at the profit only, the Company will fail to look at the actual profitability and potential of a business. The profit is calculated as:

Profit = Revenue – Costs

There’s a possibility that two companies have equal profits, but one is less profitable than the other. How can we calculate the profitability and compare them across different industries? For this, profit margins, also known as gross profit margins, are used to make financially sound decisions at the right time.

The units of profits are given in the currency of a country. On the other hand, the profit margins are provided in percentage or ratio. Profit margins are preferred over profits when comparing businesses in the same industry or sector.

 

If you are keen to analyze how profitable your business is or intend to grow your business beyond limitations, we have got you covered with professional solutions. Get in touch to get instant help!

 

Example

Let’s suppose Company A is earning a gross profit of £100,000 with sales of £200,000 and a cost of £100,000 and Company B is also making a profit of £100,000 with sales of £150,000 and a cost of £50,000. Although these two companies have equal profits, are they equally profitable?

              Measures

Companies

Sales Revenue Cost Profit Profit Margin
Company A £200,000 £100,000 £100,000 50%
Company B £150,000 £50,000 £100,000 33.3%

 

Calculating profit margins does not require cumbersome calculations. You only need two numbers: cost and net sales. Divide them and multiply the resulting number by 100. Let’s calculate profit margins here!

Profit Margins of Company A = Cost/Net Sales

                                                               = £100,000/£200,000

                                                               = ½*100

                                                               = 50%

Profit Margin of company B = Cost/Net Sales

                                                            = £50,000/£150,000

                                                            = 1/3*100

                                                            = 33.3%

Company A performs better than Company B as the profit margins differ considerably with equal profits. So, you need to calculate the profit margin if you want to decide on increasing your profits, cutting costs, or want to invest in a stock.

The business people take crucial decisions and can achieve their target of higher profitability by changing the profit margin. There are three methods to increase the profit margins. The first method is to increase the net sales or revenue. Cutting costs is also a technique adopted by many companies to manage their finances.

The third method is a mix of these two strategies. A business can increase sales either by a price hike or reducing the cost. However, the price increase is possible only if a firm is strong enough not to lose its market share. On the other hand, the cost reduction is favorable only if it does not affect the overall performance of a company.

Each of the above strategies is accompanied by specific limitations as they can make your business more profitable or detrimental to its growth. This is why profit margins are preferred while comparing margin vs profit, as it provides a broader picture than the profit alone.

 

Why are Profit Margins Essential to Tracking your Business?

Profit margins are significant to tracking your business for many reasons. Profits margins help the companies evaluate their financial decisions and decide what will ultimately upturn their profitability. Besides, there are other benefits that cannot be neglected. Let’s discuss all of them!

1. Measures Financial Health

Net profit margins help businesses manage their finances efficiently and effectively. For this, profits alone cannot help scrutinise the finances with efficacy. Adding financial value to a business is possible when you know where the problem is and how to cure that problem.

The profit margin diagnoses the financial problem and provides a financial treatment in the face of increasing sales and cutting costs.

2. Analyze Management Decisions

Secondly, you can analyze how the management makes decisions to grow a business. If you want to buy stocks of a company, you can examine the management by looking at this measure. Are the decisions helping the Company grow, and how the Company will perform in the future? To find an answer to this question, you can calculate the profit margin.

3. Cost Shifts

Thirdly, you can measure profit margins to calculate the costs and how they can be reduced. For example, you can increase the profitability ratio by reducing costs that are draining your profits. On the other hand, you can discover ways to increase sales and net revenue by making different cost decisions.

4. A Realistic Measure

Lastly, the profit margin is more realistic than profit, and it is a relative measure and does not provide absolute profitability. Suppose you want to know the actual growth of your Company. In that case, you may need a comparable number of profit margins as there is the possibility that you may have higher profits with unnecessary costs that need to be reduced.

 

Conclusion

Lastly, measuring profit is ideal when a business wishes to look at the net revenue. On the other hand, profit margins are calculated when a company expects to analyse its overall financial health. Profit margins provide a much larger picture of a business’s finances, management, and efficiency. A lower profit margin reflects poor management decisions and lower growth perspectives.

So, we can say that profit margins help a business in several ways and provide specific instruments to increase profitability. A company can either reduce costs or increase prices to increase net sales. However, there are certain limitations associated with each decision that needs to be considered before making a final decision. Margin vs profit provides a certain degree of analysis where you can make crucial decisions.

 

For more information on profit margins and other business profit measures, talk to our professionals at Accounting Firms in UK. Enjoy the sound of seamless processing!

 

Disclaimer: All information described in this blog is written for general information only.