Profit margin is calculated with selling price (or revenue) taken as base times 100. It is the percentage of selling price that is turned into profit, whereas "profit percentage" or "markup" is the percentage of cost price that one gets as profit on top of cost price. While selling something one should know what percentage of profit one will get on a particular investment, so companies calculate profit percentage to find the ratio of profit to cost.
The profit margin is used mostly for internal comparison. It is difficult to accurately compare the net profit ratio for different entities. Individual businesses' operating and financing arrangements vary so much that different entities are bound to have different levels of expenditure, so that comparison of one with another can have little meaning. A low profit margin indicates a low margin of safety: higher risk that a decline in sales will erase profits and result in a net loss, or a negative margin.
Profit margin is an indicator of a company's pricing strategies and how well it controls costs. Differences in competitive strategy and product mix cause the profit margin to vary among different companies.
- If an investor makes $10 revenue and it cost him $1 to earn it, when he takes his cost away he is left with 90% margin. He made 900% profit on his $1 investment.
- If an investor makes $10 revenue and it cost him $5 to earn it, when he takes his cost away he is left with 50% margin. He made 100% profit on his $5 investment.
- If an investor makes $10 revenue and it cost him $9 to earn it, when he takes his cost away he is left with 10% margin. He made 11.11% profit on his $9 investment.
On the other hand, profit percentage is calculated with cost price taken as base
Suppose that something is bought for $50 and sold for $100.
- Cost price = $50
- Selling price (revenue) = $100
- Profit = $100 − $50 = $50
- Profit percentage = $50/$50 = 100%
- Profit margin = ($100 - $50)/$100 = 50%
- Return on investment multiple = $50 / $50 (profit divided by cost).
If the revenue is the same as the cost, profit percentage is 0%. The result above or below 100% can be calculated as the percentage of return on investment. In this example, the return on investment is a multiple of 0.5 of the investment, resulting in a 50% gain.
- Earnings before interest and taxes
- Earnings before interest, taxes, depreciation, and amortization
- Gross profit margin
- Net income