Figuring the Profit Ratio for a Business - dummies

Figuring the Profit Ratio for a Business

Business is motivated by profit, so calculating the profit ratio for a business is very important, to say the least. The bottom line is not called the bottom line without good reason. The profit ratio indicates how much net income was earned on each $100 of sales revenue:

Net income ÷ Sales revenue = Profit ratio

The business in the following figure earned $32.47 million net income from its $457 million sales revenue, so its profit ratio equals 7.1 percent, meaning that the business earned $7.10 net income for each $100 of sales revenue. (Thus, its expenses were $92.90 per $100 of sales revenue.)

An income statement example for a business.
An income statement example for a business.

Profit ratios vary widely from industry to industry. A 5 to 10 percent profit ratio is common in many industries, although some high-volume retailers, such as supermarkets, are satisfied with profit ratios around 1 or 2 percent.

You can turn any ratio upside down and come up with a new way of looking at the same information. If you flip the profit ratio over to be sales revenue divided by net income, the result is the amount of sales revenue needed to make $1 profit.

Using the same example, $457 million sales revenue ÷ $32.47 million net income = 14.08, which means that the business needs $14.08 in sales to make $1.00 profit. So you can say that net income is 7.1 percent of sales revenue, or you can say that sales revenue is 14.08 times net income.