The Difference Between Profit & Profit Margin
In order for a business to determine how healthy it is, it must look at several different metrics. Two of these metrics are found on its income statement, namely profit and profit margin. By analyzing these two figures, businesses can get a sense of how they performed over a period of time and what they can do to improve their operations.
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Profit
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Profit, also known as net income, is simply a dollar amount calculated when all the expenses for a particular period are subtracted from all of the revenues from that period. If this number is positive, the company makes a profit. That money is then placed into retained earnings for the company or given out to the company owners as a return on their investment.
Profit Margin
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Profit margin is a ratio that states how well the company did at keeping earnings as profit. It measures, as a percentage, how much of each dollar of revenue is kept by the company. To determine this number, owners have to divide the profit number by the amount of revenue\ taken in. For example, if a company made $100,000 in revenue and had a net income of $40,000, then the profit margin for that period would be 40 percent ($40,000 / $100,000 = .40 or 40 percent).
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Profit Margin Vs Profit.
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While both of these metrics have the word "profit" in them, they are not interchangeable. Profit gives a cold hard number with regard to how much money was made by a company, however, it does not tell the entire story. Without looking at the profit margin number, there is no way to tell how the company did at controlling expenses and how much of the sales flowed through to the bottom line. Just because a company makes a huge profit, doesn't necessarily mean it is successful because it may have extremely low profit margins.
When to Use What
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Look at the profit when you are trying to determine how a company is doing over time. If the company profits rise from year one to year two to year three, you know that the company is experiencing a degree of success over time. However, if you want to compare businesses which are similar, profit margin is often a better metric to use because it will show you how like companies controlled their costs, regardless of size.
Increasing Profit and Profit Margin.
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Increasing each of these figures can be done in almost the same way. If you increase your revenue while keeping your costs constant or you decrease costs while keeping revenue constant, both the profit and profit margin will increase. However, it is possible to increase one of these figures without increasing the other. For example, you may increase your revenues but increase your costs as well. When this happens, your profit may go up, but depending on the costs associated, there may be no change in the profit margin number.
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References
- Photo Credit profit image by Jaroslaw Grudzinski from Fotolia.com
