A profit margin is an indicator of profitability, expressed as a percentage. Net profit margins show how much revenue is retained after all costs and taxes are paid. There are simple formulas for calculating each. Let’s have a look at the basics.
In order to figure out a profit margin, you need to know your business’s net income and revenue. You can then find the profit margin with the formula:
Profit Margin = (Net Income √∑ Revenue) x 100
Net Income is reported on Form T2125 of the income tax return for your business. Recall that if your business is incorporated, a corporate tax return is required. Members of a partnership can also find their net income amount on the T5013 Statement of Partnership Income slip. Net income is what remains after other partners subtract their shares of the income.
First, determine your gross business or professional income or your gross profit. These amounts are entered on line 8299 of Part 3C or line 8519 of Part 3D on the T2125 form. Business income may include gross sales, commissions or fees. Professional income may include gross professional fees including work-in-progress (WIP). Gross profit may include gross business income, minus costs incurred for:
* Be sure to follow the CRA's guidelines for inventory valuation. For each item, determine the cost at which it was acquired and the fair market value. Use the lower amount for tax purposes. For the entire end-of-year inventory cost, use fair market value at the end of the year.
Fortunately, business expenses can be deducted from your total income. In many cases, those expenses are fully deductible. Others can’t be deducted dollar for dollar, but you still get a tax break for paying them. Thus, it's a good idea to add up the business expenses incurred for:
Subtract the total amount from the amount entered as gross business or professional income (line 8299 of Part 3C) or gross profit (line 8519 of Part 3D). Report the result on line 9369 of the T125 form.
Take the amount entered on line 9369 of the T2125 form. Add the amount of the GST/HST rebate for partners that was received in the year. Subtract other amounts deductible from your share of the net partnership income. You can then subtract any business-use-of-home expenses. The result is your net income. Now all you need to figure out your profit margin is your revenue. What was that formula again? Profit Margin = (Net Income √∑ Revenue) x 100. We're on our way!
A simple way to find your revenue amount is to add up amounts from:
Source: Statistics Canada report, Financial Performance Indicators for Canadian Businesses (1998) infoentrepreneurs.com offers these things to consider to calculate revenue, as suggested by Canada Business Ontario. Some of these appear on the lists above, but they're good to keep in mind:
The Business Development Bank of Canada uses a simple formula for its net profit margin calculator:
Net Profit Margin = (Net profit or income, after taxes √∑ Net sales) x 100
You can see how to determine net income above. The term "net" usually implies that whatever follows is an after-tax amount. The personal tax equivalent to net profit might be taxable income.
You need to find the figure that reflects your net sales to calculate net profit margin. To do that, figure out your gross sales, and subtract any returns, rejects (including damaged or missing goods) and applicable discounts. The result is your net sales. Gross sales numbers depend on whether you use the cash method or accrual method of accounting. With the cash method, include only sales for which payment has been received. With the accrual method, income and expenses are reported as they are incurred, regardless of whether payment has been received. Net sales are a key indicator of a company's profitability in the eyes of investors. Even if your business is privately owned, net sales numbers are a good way to measure your progress.
Net Profit Margin = (Net profit or income, after taxes √∑ Net sales) x 100
Some refer to net profit margin as a business's bottom line since it reflects its profit after taxes. Net profit margin is also called the return on sales ratio.
Net profit margin shows exactly how much after-tax profit each sales dollar brings in. What percentage of your revenue does your business keep once all operating expenses, creditor interest, and income tax are paid? That's net profit margin. High net profit margins are thought to prove that a company is running well. If yours is higher than a competitor's, it could mean that your business is more efficient and adaptable. It's a way of situating yourself with regard to others in your industry. Even if you experience a decrease in net profit margin, remember to keep an eye on your peers. Perhaps the whole industry has been experiencing a decline. Maybe you're doing better than you think. While a strong net profit margin is a sign that a business is doing well, there are other factors to keep in mind. For example, investors may consider a business's liquidity as well.
When you calculate your profit margin or net profit margin, you get a picture of the overall health of your business. Statistics Canada considers these and other figures when it seeks information about businesses and industries. Here are a few others from their list.
A balance sheet shows a business's total assets, liabilities, and equity.
An income statement includes revenues, expenses, gains and losses, income taxes, and various measures of profitability.
These figures show the necessary adjustments needed to compute taxable income and taxes payable.
Working capital is the ratio between a business's current assets and its current liabilities. It shows how easily a business is able to pay short-term debts. The formula for working capital is:
Current assets √∑ Current liabilities
Receivable turnover shows the quality and relative size of your accounts receivable. How often are accounts receivable converted into cash during the year? The formula to find receivable turnover is:
Sales of goods and services √∑ Accounts receivable
The CRA encourages both new and existing businesses to consult its resources on Financial Performance Data. You can find information on over 1000 industries. Reports use various benchmarks to provide statistics for profitable and non-profitable small and medium-sized businesses. If you know about the other businesses in your field, you can build a better business plan. You can plan out your future with confidence when you know which financial factors will likely affect your business. Remember to keep accurate and complete records!