Profitability measurements are often among the most important calculations for a business. Profit margin is a standard calculation for individual products and product lines. The calculation informs a business how much income the product brings to the company after it pays for the cost of the item. Most companies prepare this number for the aggregate total of all product sales.
Identification
The basic formula for profit margin divides net income by sales. To convert this to an individual product profit margin, the formula divides net profit by the product's sales price. The net profit from a product is the sales price less the item's cost. Companies often compute a product or product line's profit margin to determine how much income each item will bring to the business.
Example
Heather's Widget Factory manufactures widgets for $5 each. Heather plans to sell each widget for $8, which results in a profit margin of 38 percent. The Widget Factory also produces special items called wodgets, a new hybrid widget/cog model. These cost $6.50 to manufacture and have a $9.75 sales price; the profit margin for these items is 33 percent.
Purpose
Computing profit margins allow a company to determine how much net profit they can expect solely from selling goods. In the example above, even though the wodget has a higher sales price, it also carries a lower profit margin. The company may benefit more from producing widgets because the business will gain more net profit from the sale for these products.
Considerations
Companies can use profit margin figures to determine how well their business operates compared to the industry standard. For example, if the widget industry has an average 40 percent product profit margin, then Heather's Widget Factory is less efficient at producing widgets. She will need to improve operations in order to lower production costs or raise the sales price in order to compete with the same product profit margin in the industry.
Tags: sales price, profit margin, profit margin, product sales, Widget Factory, determine much, Heather Widget
