There are a fairly large number of different profitability indicators, all of which are determined in order to understand how efficiently the work of the entire enterprise is carried out, as well as its personnel, capital, funds and many other elements. Only after all the coefficients have been determined regarding the payback of this enterprise, it will already be possible to draw certain conclusions about its work.
A single coefficient, including also the profitability of sales, will not say almost anything and is an exclusively occasion to conduct a more detailed analysis of the company.
Profit Margin Analysis
The profit margin is in this case the estimated ratio. Return on sales allows you to see the share of revenue in net profit, and also to show what exactly the share of profit this company has with each individual unit of products sold by it.
The ratio will never allow you to determine how profitable (or unpromising) this or that investment is, since to answer this question you need to have a complete list of indicators on the capital and assets of your company.
How is it determined?
Profitability of sales is determined in most cases in three different ways, each of which directly depends on the numerator, while the denominator, which in this case is the revenue, will always remain unchanged.
You can determine the profitability indicator for the entire company, its individual division, department or even completely for the entire industry. Since in this case the analysis is considered, its circle may, if necessary, narrow or expand.
You should take into account the fact that the profitability of sales shows the efficiency of use by a company of all the resources that it has at its disposal, but it does not show the efficiency of the company itself, because it can always have a sufficiently large amount of debt or an insignificant part in assets.
Indicator measurements
In order to understand how this indicator changes under the influence of various factors, you should consider several different options. An increase in profit margin may be present in the following cases.
Revenues increase due to cost minimization
In the event that a company sells certain products more than in the previous period of time, or if the company changes its own assortment, the coefficient inevitably increases, and its indicator is an excellent payback characteristic of this company. Cost minimization is due to a number of very different reasons, among which we can single out a reduction in the cost of equipment, energy, materials and much more.
Among other things, when calculating the net profitability of sales, you should also consider the balance of changes in variables and fixed costs for investments, in which you will need to achieve a certain balance, given that the changes in various indicators of these costs do not have any direct mathematical dependence.
Revenue and expenses are reduced, but costs are reduced faster.
In certain situations, this is due to rising prices for manufactured products.From this we can conclude that the net return on sales is formal, because in general the picture is rather unfavorable.
At the same time, despite the fact that the profit margin is quite high, the price policy should be reviewed as quickly as possible, because the drop in revenue is in any case an extremely negative indicator.
Revenue increases, costs grow more slowly
Return on sales shows a variety of results that can be perceived positively if in the dynamics this indicator is stable and does not change. Such changes occur due to a variety of factors:
- while reducing costs for all kinds of costs;
- in the event of certain changes in the range of products manufactured by this enterprise;
- in case of price increase.
At the same time, a decrease in this coefficient can occur in the cases described below.
A simultaneous increase in profits and expenses when expenses begin to increase much more
This trend is definitely negative, and in any case requires the most urgent analysis of all costs, the proposed range, as well as the cost of marketable products. The occurrence of such a situation is possible with an increase in the cost of goods, which often occurs, for example, due to the rise in price of energy.
Revenue decreases faster than expenses
In the event that the company decided to deliberately reduce its influence in the current market or completely curtail certain production, the declining sales margin is absolutely normal, and in this situation, any similar trends will be observed. If the drop in revenue is unforeseen, then in this case you should conduct a detailed analysis of the marketing of your company.
Expenses are rising, while revenue is falling
This state of affairs is possible in the event of a decrease in the success of the enterprise, with adverse changes in the proposed assortment, as well as rising costs. In this case, you should use a comprehensive analysis of profitability of sales:
- pricing is completely revised;
- revised cost control, as well as company policy in relation to the proposed range.
If a company operates in an unstable market, then the margin may directly depend on inflation, changes in demand for products in general, or competition.
Calculation Formulas
Considering the profitability of sales, the formula can be very different, but there are several basic ones.
Net profit margin = 100% of net profit divided by revenue
Net profit margin is also commonly referred to as net sales margin. The definition of this indicator is relevant for several periods. Because only in such a situation it will be possible to give a truly objective assessment of not only the activities of the company, but also its overall payback.
When assessing jumps or the stability of the coefficient, we can draw several conclusions:
- literacy or, conversely, illiteracy of decisions;
- how efficiently various resources are currently being used;
- about the success or problems in the work of the company.
As can be seen from the formula itself, changes in this coefficient to one of the parties are caused by a change in the profit indicators from sales, as well as a decrease in the number of products sold and other reasons. In this case, if sales profitability is calculated, the formula will show the current situation, and it will be important to find the problem or the reasons that caused the indicator to change in one of the parties and eliminate them.
Features
You should be wary if, for any reason, buyers have begun to noticeably lose interest in the products you offer. In this case, the profitability ratio of sales may decrease in the process of modernizing your production or in the process of conquering the market, moving to other activities or products.
In the event that the overall management strategy is far-sighted and reasonable, all the losses present at the moment will be fully recovered in the course of further work.
Gross profit margin = 100% of gross profit divided by revenue
On the income from the main business of the company, which represents the difference between net profit, as well as direct and operating expenses, is the return on sales.
Operating profitability = 100% profit without interest and taxes is divided by revenue
Immediately it is worth noting the fact that, in principle, when calculating the profitability of sales, there is no such thing as a “norm”, since the coefficient that is optimal for a particular industry will subsequently be very low for another. Each individual company has its own cycle, and if there is a long cycle, the profitability ratio will be greater, while with a quick turnaround it will decrease, and all this applies to conditions of completely identical efficiency of all structures.
The calculation of profitability of sales, which is an indicator of the profitability or profitability of a particular company, is often used in case you need to consider the payback of a given enterprise. Of course, any indicators of this type are important, since their values completely characterize the investor's investment object, as a result of which the analysis of profitability, as well as the assessment of well-being from a financial point of view, are quite serious aspects that apply not only to investment risks, but also relate to the appropriateness of a particular company or firm, that is, this is the most optimal way to determine the state of affairs.
In this case, it is important not to forget that in itself product profitability (sales) is not an indicator of performance. Indeed, in fact, the higher the value of profitability, the greater the risks. Thus, it would be impractical to state unequivocally that a company is effective if it has a sufficiently high rate of return on sales. After all, perhaps she burdened herself with too much debt.
Given all this, the company’s specialists conduct a thorough analysis of the profitability of sales of certain types of products and, based on this, can give recommendations on how to act and what needs to be changed in order to optimize the financial condition of the company in the future and maximize it.
