Comparing profitability

Looking at profit as a money amount can mislead you when businesses are different sizes. A £22,500 profit sounds stronger than a £14,400 profit, but it depends on the sales revenue needed to earn it. A percentage such as a profit margin shows profit relative to sales revenue, so it allows a fairer comparison.

Willow Crafts earns less profit in money terms, but it keeps 25p of net profit from every £1 of sales, compared with 12.5p for Harbour Sports. Relative to its sales, Willow Crafts is more profitable.

Money amounts and percentages

Gross profit and net profit are money amounts. Gross profit margin, net profit margin and average rate of return are percentages. A money figure tells you size; a percentage tells you the rate or proportion. You need both to judge performance fairly. Average rate of return does the same job for investments: it expresses the average annual profit as a percentage of the cost of the investment, so projects of different sizes can be compared.

Finding profit from a margin

If you know sales revenue and a margin, rearrange the margin formula: Profit = (margin ÷ 100) × sales revenue. For example, a stationery shop has sales revenue of £48,000 and a net profit margin of 15%. Net profit = 0.15 × £48,000 = £7,200.

Being able to switch between money and percentage forms helps you interpret financial data and answer questions that ask you to compare performance.