Profit Margin Ratio | Analysis | Formula | Example

Profit Margin Ratio

Profit margin ratio is also known as return on sales ratio or gross profit ratio. It is the profitability ratio which is used to measure the amount of a net income earned with each dollar of sales generated. It is calculated by comparing the net income of the company with its net sales. In other words, PM ratio shows the leftover sales after the payment of all the expenses of the business.

Creditor and investors use this ratio to find the efficiency of the business to convert the sales into the net income.  Investors want that the company in which investors invest is more profitable. On the other hand, creditor wants that the company has enough profit to pay back its loan.

To set the performance goal for future this ratio used by the management of the business.

Formula

Profit Margin ratio formula can be calculated by dividing the net income by net sales.

Profit Margin Ratio = Net income/Net sales

By subtracting the returns or refunds from the net sales of the company we calculate the net sales for the above formula. Whereas by subtracting the total expenses from total revenue we calculate the net income. On the income statement net income reported at the bottom line.

Analysis

How much profit produce at a certain level of sales, can be calculated by the PM ratio.

To find the efficiency of the company to manage its expenses relative to its net sales, indirectly measure by this ratio. The company wants to make this ratio high that’s why companies generating high revenue by keeping the expenses low.

For the comparison of same size companies across 1 industry, profit margin ratio is useful like other profitability ratios. Through this ratio analysts and management measure the company’s past performance.

Example

Nicky has the retailer store. 10 years before she opened this store. Best selling year for Nicky is the last year in which her net sales were 1,000,000 dollars and 100,000 dollars net income. Return on sales ratio for Nicky can be calculated as

Profit Margin Ratio

10% = 100,000/1,000,000

From the above result, we can say that her 10% sales convert into profit. So she has net sales of 800,000 dollars and 200,000 is her net income if contrast with the current year numbers.

Updated: October 8, 2019 — 10:40 pm

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