The Profit Margin

By Michael C. Dennis. CPC, CCP, CBF

In accounting, the profit margin is a key financial ratio that measures the percentage of revenue a company retains as profit after accounting for all expenses. It is calculated by dividing net income by net sales and multiplying by 100 to express it as a percentage:

Profit Margin = (Net Income / Net Sales) × 100%

This ratio provides insight into a company's overall financial health and its efficiency in converting sales into actual profit. A higher profit margin indicates better control over costs relative to sales, suggesting a more profitable and potentially lower credit risk customer. Credit professionals analyze profit margins to assess a customer's ability to generate earnings, which aids in evaluating their creditworthiness.

It's important to distinguish between different types of profit margins:

• Gross Profit Margin: Calculated by dividing gross profit (net sales minus the cost of goods sold) by net sales. This metric assesses a company's efficiency in producing goods and services.
• Net Profit Margin: As defined above, it evaluates the overall profitability after all expenses have been deducted from revenues.

By comparing these margins across different companies or against industry benchmarks, credit professionals can gauge earning expectations and assess a company's return on investment. This comparative analysis is crucial for making informed credit decisions.