Standard Business Industry Profit Margin & Analysis

Introduction
Profitability ratios determine how well a company turns sales revenue into net income. Both initial figures come from a company’s income statement. The ratio essentially tells a company what part of every $1 in sales will result in profits retained by the business. Standard profit margins may exist for various industries.

Basic Formula
The basic profit margin formula is dividing net income by sales revenue. An alternate formula is to use net sales, which are gross sales less any returns, discounts or allowances. The alternative formula presents a more accurate picture as it account for these extra items, which will lower the sales revenue a company reports on its income statement. For example, $5,000 in net income divided by $23,000 in sales revenue results in a 22 percent profit margin.

Standards
Standard profit margins generally do not exist in business. Industries may have an average that all companies can benchmark against, however. For example, the automotive retailer industry may have an average profit margin of 30 percent. A company that is below this average is not operating as profitably as other businesses in the industry. Companies can also set internal standards for profit margin. In other cases, owners may desire a 40 percent profit margin, which is the internal standard for the business’ operations.

Accounting Estimates
Accountants often provide estimates for companies needing to set standard profit margins. For example, accountants may use averages taken from income statements released by businesses in certain industries. Accountants break information down by categories in the income statement. Sales is 100 percent; accountants then state cost of goods sold should be 75 percent of sales, expenses 15 percent and net income five percent. These estimates become the internal standards by which accountants will judge future financial statements.

Considerations
Profit margin is just one figure a company should compute during the financial analysis process. While the figure can report a company’s profitability, the formula leaves out analysis from other important accounting figures. For example, liquidity, asset turnover, financial leverage, and other ratios exist for analyzing a company’s accounting data. Using each ratio group should be a standard process so companies can have a better understanding of all activities conducted in normal operations.