The profit margin ratio compares the earnings of a company to its sales. It plays an important role in indicating the financial health of an organization. To calculate the profit ratio, the net profits are divided for a reporting period by the net sales for the same period.

Investors and creditors consider this ratio an important ratio as it is used to measure how efficiently a firm can convert sales into net income. Investors want to be assured that profits are high enough to distribute dividends while creditors want to to be assured that the company has ample profits to pay off its loans. Simply put, outside users want to know that the company is operating efficiently. An extremely low profit ratio would indicate the expenses are too high and the management needs to budget and cut expenses.

Formula of Profit Margin Ratio

Profit Margin Ratio = Net Profit/Net Sales