12. Profit Margin

Let's talk about profit margin. Profit margin is a straightforward ratio of net income over sales. If you'll remember from the last video about gross profit, we decided that gross profit was sales minus cost of goods sold equals gross profit. And then we had a bunch of operating expenses, salaries, rent, wages, insurance, all that good stuff. And then finally, you get all the way to the bottom, and you've got net income.

So net income is the net or whatever's left over of all the sales, right? It's the net income. Makes enough sense. So if you had $1,000 in sales, and after all these expenses got paid, you had $100 in net income, well, then your profit margin would look like this. You'd have 100 over 1,000, and that would be 0.1 or 10%. You always express it as a percentage. So you'd have a 10% profit margin. And so what does that help us do? Well, that helps us say if I was to sell another $100, I can expect another $10 to get to the bottom line.

So you can say sales times profit margin equals net income. And so you can use this kind of thing for forecasting from year to year, forecasting throughout the year. If you expect sales to hit a certain number at the end of the year and you kind of know what your profit margin is, you can forecast what your net income is gonna be. You can also compare this to an industry average. You can compare it to yourself over the past five years. This is really just a helpful key metric to know how am I doing, where can I expect to be in the future, how am I doing against myself, how am I doing against competitors.

And the layman's terms or the way that you can think about profit margin is, what percentage of my sales makes it to the bottom line? And bottom line is not some jargon. Bottom line actually means the bottom line, the last thing at the bottom, net income. So profit margin is a ratio that says what percentage of my sales makes it to the bottom line.

You sold 1,000, 100 made it to the very bottom. Your profit margin is 10%.