Profit rate, or profit margin, is the net profit divided by revenue generated for the same period. It determines the percentage of revenue retained as profit after all expenses and taxes are paid. Acceptable levels vary by industry, and cost-cutting strategies can improve profit rates.
Also known as the profit margin, the profit rate is simply the net profit that remains after taxes are calculated and paid, divided by sales or revenue generated for the same period. The idea behind this type of ratio or margin is to determine the percentage of revenue that is actually retained as profit when all related expenses are accounted for and paid in full. Typically, a company calculates a profit rate for the twelve-month period, although in some industries it is common for this type of calculation to occur on a quarterly and annual basis.
To start the process of determining the rate of profit, it is first necessary to arrive at the net profit that serves as the basis for the calculation. Essentially, net income is simply what remains after all relevant expenses have been deducted from the gross income generated for the period considered. What constitutes net income varies somewhat from country to country, with some companies focusing on actual production expenses and omitting administrative expenses. In other scenarios, any expenses related to operating the business are deducted from gross profit. In either approach, taxes are also deducted, leaving a figure that is often referred to as after-tax net income.
Once the net profit is established, this number is divided by the sales generated in the same period. In some situations, companies prefer to go with collected revenues rather than actual sales, as some of the sales made during the period may not have been collected at that time. The resulting number is usually shown as a percentage. A higher percentage means that the business is keeping more of the net profit generated, while a lower percentage confirms that the business is not keeping much of the net profit that was realized during the period considered.
What constitutes an acceptable profit rate level will vary from one setup to another. For example, a rate of 20% might be considered reasonable in one industry, but extremely low in another. Even when the profit rate is considered favorable, it is not uncommon for business owners and key management team members to analyze the costs associated with the production process, looking for ways to reduce these costs and increase the amount of net profit realized in the next period. . Assuming this can be accomplished without having a negative impact on sales or revenue generated during this period, it is likely that implementing new cost-cutting strategies will result in the profit rate improving.
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