Increase in revenue does not necessarily mean an increase in profitability! Without this knowledge, most small and some large scale business owners lacks clarity with terms to define basic accounting. Some misinterpret gross profit for net profit and vice versa. These two statistics are vital and it very important to know the difference between them, been able to distinguish the two will aid more clarity in the company’s managerial aspect that needs refining or modification; which will, in the long run, increase the business profitability and success.
However, profitability in a company simply means the quality of being able to yield profit from its normal and regular business functionality or general operation at large. In this case, the parameter for analyzing the company’s profit making capability is referred to as profitability ratio. This ratio is grouped into three namely; the Gross profit margin, Net profit margin and the Operating profit margin. Nevertheless, we are about to consider the first two, read through as we shed light on them.
Generally, Net profit and Gross profit margins are been computed using Cost, Revenue, and Expenses in the company’s income statement. These two are very functional when investors are comparing the company’s previous and current performance within the same sector. Their significance comes in place as Net profit margin indicates the relative profitability of the company with respect to the previous performance and other businesses alike; while Gross profit margin indicates the company’s overall efficiency. Let us consider them one at a time.
Net Profit Margin
The net profit margin is the accurate measurement of a company’s profitability, due to the fact that it reveals the degree of the company’s revenue in percentage, which actually reflects the company’s profit per monetary income (per dollar) of sales.
Mathematically, Net profit margin can be represented as NP= (R-C-OPE-OP-I-T)/R
Representation of Data:
Net profit margin = (Revenue minus Cost of goods, minus Operating expenses, minus other expenses, minus Interest minus Taxes) All divided by Revenue
NP= Net profit margin, R=Revenue, C= Cost of goods, OPE= Operating expenses, OE= other expenses, I- interest, T=taxes
Therefore, forecasting the company’s future profit can be done through Net profit margin. Also, for this margin to rise in future, the company can use this statistic to eliminate its fixed/variable expenses. Thereby offering the company an ongoing picture with full capability to earn more income and promote productivity.
If there seems to be any reduction in the net profit margin, the management is meant to take instantaneous action by reducing the product cost or generate more revenue through marketing. if not the company productivity might prove insufficient.
Gross Profit Margin
Gross Profit Margin as stated above simply measure, with indication how well a company is managing its major business activities which include labor, purchased materials that are used, and other direct expenses to enhance the rate of the company’s profit. Gross Profit Margin connotes the financial tool which is employed to identify the financial health of the company. It, however, represents the amount of money left after the deduction of the cost of production from the sales.
Mathematically, Gross profit margin can be represented as GP=(R-C)/R
Gross profit margin = (Revenue minus Cost of goods) / Revenue
The knowledge of the company’s average gross profit is a key piece of information. This determines how successful your company is compared to your competitors.
The clarity of making choices either to bring down costs in order to attract new customers can be made you can also consider new ways to produce your goods more cheaply comes through the knowledge of the Gross profit margin.
Gross profit margin pictures the distinction between production or delivery of the product to the seller and its selling price; this is solely based on improving the company’s profit.