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All trading basics

Profit Margin Ratio

Profit Margin Ratio = Net Income ÷ Revenue

Indicates what portion of sales contribute to the income of a company.

Things to remember

  • This ratio is not useful for companies losing money, since they have no profit.
  • A low profit margin can indicate pricing strategy and/or the impact of competition on margins.
Income Statement
Consolidated income statement for Cory’s Tequila Co. for 1998 and 1999

For Tequila Cory inc $2,096 ÷ $12,154 = 0.17

Profit Margin Analysis:

A profit margin ratio of 17% that for each dollar of sales that Cory's Tequila Co. generates it is contributing 17 cents to its bottom line (net income). Tied in with gross profit margin, Cory's Tequila Co. has a healthy pricing strategy which is evident in both ratios. In cutthroat pricing industries such as retail and gasoline you would expect the profit margin to be much lower because of heavy competition. We can deduce that Cory's Tequila Co. either has exceptional products, for which customers are willing to pay a substantial premium, or that Cory's Tequila Co. really doesn't have much competition and they can therefore charge what they wish.