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Business Financials – Profit & Loss and all about Profit Margins
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Published on Thursday, 30 April 2015 11:26
A business reports how it is going monthly and yearly, on the Profit & Loss Statement (or P&L) or Income Statement, and from this statement we can calculate Business Health Ratios that give insight to the financial health of the business.
The P&L shows all the sales for a period less cost of goods (if you sell product) leaving gross profit, then from that all the expenses (operating or overheads like rent, wages etc) leaving the operating profit (not always reported), then from that less any non-regular income and expenses, gives us the final net profit.
To summarise, there are three main levels of profit or profit margins and they are calculated as follows:
Gross profit (after cost of sales deducted from sales/revenue), calculated by Gross Profit / Sales (ie GP divided by sales);
Operating profit (sometimes given = after expenses deducted) also known as Pre-tax profit (before tax and other non-regular items) calculate by Operating Profit / Sales (ie OP divided by sales), and so on; and
Net profit (Final, after tax and other non-regular expenses and income).
Note that “profit”, “earnings” and even “income” are all used interchangeably, and mean the same thing.
When the term "margin" is stated, it can apply to the absolute dollar number for a given profit level and/or the number as a percentage of sales/revenues.
The net profit margin commonly uses the percentage calculation to provide a measure of a company's profitability on a historical basis (3-5 years) and in comparison to peer companies and industry benchmarks. The margin is the amount of profit (at the gross, operating, pre-tax or net level) as a percent of the sales generated.
The observation of profits over years can detect consistency or positive/negative trends in a company's earnings. Positive profit margin analysis translates into positive investment quality. To a large degree, it is the quality, and growth, of a company's earnings that drive its stock price, as well as earnings per share and Return on Equity.
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