Calculating the profit margin is one of the most important things that the owners of companies and projects look for because the profit margin is one of the factors that indicate the success of projects and institutions, in addition to being an indicator used to measure the extent of the project’s success and strength, and to identify the different ways to do the process of calculating the margin, follow this article.
What is the profit margin?
Many definitions have been launched on the profit margin, although all of them aim to achieve high profitability rates within the institutions. These definitions include the following:
- It is the financial returns that people who own businesses get as a result of investing in certain things.
- It also means the difference between all revenue generated from sales and the production costs used in production.
- It can also be expressed as the difference between the purchase cost or price of the good or service and the price at which it was sold.
- It is also the amount of money he contributes to commercial projects after deducting various types of costs, whether fixed or variable, as well as production units.
profit margin calculation
The profit margin is calculated by:
- Profit Margin = Net Income / Net Sales.
- Net Sales = Total Revenues - Sales Allowances - Sales Returns - Discounts.
- The profit margin can be calculated as a percentage using the following equation:
Factors affecting the profit margin calculation
Several factors may significantly affect the profit margin, including the following:
- Variable costs: These costs are represented in wages and raw materials. The higher the prices of raw materials and the wages paid to workers, the lower the profit margin.
- Selling price: This happens when the selling price of units and goods increases, and this positively affects the profit margin. It leads to an increase, but in the cases in which the selling price decreases, this causes a decrease in the rates and percentages of the profit margin.
The difference between gross profit margin and net profit margin
Gross profit is the profit that organizations achieve after subtracting all different types of costs, starting from manufacturing the product until it is sold, while the net profit is the amount that an individual earns after deducting or subtracting taxes, interest, and operating expenses. And that during a certain period, there is a direct relationship between the net profit and the total profit. If the total profit was low or negative, the net profit was also negative and low, and vice versa.
Methods for calculating the profit margin in banks on loans or bank interest
There are two ways in which the profit margin for loans can be calculated:
First method
In this method, the simple bank interest related to the borrowed amount is calculated. What distinguishes the simple interest is that it is fixed and does not change, but to be calculated correctly, there must be 3 elements:
- Borrowed Amount: It is the amount of money that a person has borrowed from the bank in return for simple interest and is often denoted by the symbol (m).
- Duration: It means the period during which the borrowing person must repay the amount of money in addition to its interests, and this period does not exceed one year and is symbolized by (N).
- Interest rate: It is the percentage determined by the bank on the borrowed amounts and agreed upon in advance and its symbol (P).
- The profit margin in case of simple interest is calculated as follows:
- Money Amount * Interest Rate * Period.
The second method
This method relates to calculating interest in a compound form, and the bank uses this method in cases where the repayment period exceeds a year and must include these elements, namely:
- Financial Amount: It is the amount that the bank has lent to any person and its symbol is (m).
- Duration of time: the period available to the borrower to repay the loan, and this period is more than a year symbolized by (n), and here the period differs from the original period symbolized by (t), which is the repetition.
- Interest rate: The percentage that consists of the loan amount and its symbol (P).
- The number of interest recurrences: It means the number of times the bank adds the compound interest to the original borrowed amount, which was previously determined between the bank and the borrowing person and its symbol (T).
- Compound interest = amount borrowed (1 + p/n) n*t.
- Clarification of the previous law is to multiply the borrowed amount by the interest rate divided by the period and add to it the number (1), which is a fixed number in the law, with everyone raising the exponent of the period multiplied by the number of repetitions.
The difference between Murabaha margin and interest
Many people confuse interest with Murabaha, but there is a big difference between the two terms. It is clarified in the following points:
Murabaha
- It is a contract whereby the bank buys anything of its choice and is specified by the customer from one or several other persons.
- The bank aims behind this to achieve a profit margin after selling the thing to the customer again, and the profit margin here is previously agreed upon between both the bank and the customer.
- Murabaha consists of three parts: the buyer, who wants to get the thing sold. The bank is the one who does the financing, and the seller is the owner of the original thing.
- What distinguishes Murabaha is that it conforms to the provisions and rules of Islamic Sharia.
- Murabaha The seller buys the whole thing and then sells it to the buyer, whether in installments or in cash, so the seller is the only bearer and responsible to the buyer for what was sold.
- Murabaha There is no increase in the amount during the period specified for the installments, while the interest is bearable or subject to an increase during the installment period. Or repayment due to the existence of contracts and texts that stipulate an increase in interest or its ability to be modified upwards.
Benefit
- They are amounts payable on the basic loan amount and paid by the borrower to the borrowing person or the bank when the borrower uses some specific assets such as money, assets, or consumer goods, and it is a percentage resulting from the original debt amount.
- Interest in which the bank lends the person the amount to buy the thing he wants himself, with no responsibility for the bank and no guarantee of anything related to the seller, buyer, or commodity.
operating profit margin
The operating profit margin is as follows:
- A managerial business term refers to the percentage of profit made from sales. After subtracting or deducting all variable costs used in the production process. such as raw materials and workers' wages, but without deduction of any taxes or interest.
- It helps the organization achieve high rates of profit, efficiency, and quality.
- It plays an active role in recognizing whether the level and performance in the organization are improving from time to time or not.
- Contributes to a large extent to identifying the sources of income for the institution resulting from its basic operations or resulting from other sources of investment.
- Through it, the available percentages of revenues for covering non-operating costs such as costs related to paying bills are identified.
In this article, we talked about calculating the profit margin, what is the profit margin, the methods for calculating the profit margin in banks, the difference between Murabaha and interest, the difference between net profit and gross profit, as well as the operating profit margin.
