Investment Formula Description
Profit Margin or net margin is a investment formula to measure a corporation's profitability. It is an indicator of a company's pricing policies and its ability to control costs.
It basically shows how much out of every dollar of sales a corporation actually keeps in earnings.Comparing profit margin with corporations in other industries do not have much meaning since different industries have different financing arrangment and business operating. Hence, profit margin or net margin is only useful when comparing corporations in similar industries. A higher profit margin or higher net margin indicates a more profitable corporation that has better control over its costs compared to its competitors. A low profit margin or low net margin indicates a low margin of safety, which means that corporations face higher risk that a decline in sales will erase profit and result in a net loss. Besides, profit margin shows the ability of the company to earn net profit over it sales.High profit margin corporation is able to obtain higher net profit compared with corporation with low profit margin even both corporations are earning same amount of revenue or sales.This investment formula can use to monitor the performance of the corporation's management to control the cost of the products For traditional corporations that producing same products all the while, a good management should be able to improve its profit margin year by year because they should look for opportunities to reduce cost of goods sold to improve corporation efficiencies. However, in certain industries that depends on raw materials to produce products, the corporations might lose their control to improve profit margin as the cost of raw materials is beyond their control.
Investment Formula Example
If Corporation A has total $100,000 revenue and $10,000 net profit for its financial year, the profit margin or net margin will be as following.
Profit Margin or Net Margin = Net Profit / Revenue X 100 = 10,000 / 100,000 X 100 =10 %
Corporation A is able to earn $0.10 for every dollar of sales and its has 10% of margin of safety.
Corporation A is selling its products for $10 per unit with its cost of goods sold of $7 and tax of $2. If there is a raise on the cost to $9, the profit for corporation A will erase and cause net loss as following.
Net Profit = Revenue - Cost of Goods Sold - Tax = 10 - 9 - 2 = -1
Profit Margin or Net Margin = Net Profit / Revenue X100 = -1 / 10 X 100 = -10%
Corporations with low margin of safety face higher risk to have net loss when there is a raise on the cost. In this case, Corporation A will face net loss of 10% after there is a raise of cost from $7 to $9.