Gross profit margin is a ratio that indicates the performance of a company's sales

and production. This ratio is made by accounting for the cost of goods sold—
which include all costs generated to produce or provide your product or service—
and your total revenue. If your business has a gross profit margin of 24%, it
means that 24% of your total revenue became profit.

A higher gross profit margin indicates efficient processes in a company. A lower

ratio indicates your processes may not be as efficient as they could be.

You can also use the gross profit margin to look at the effectiveness of individual
products or services. The gross profit of one product divided by the total revenue
generated by that product will display the efficiency of the process.

Net profit margin is the percentage of revenue left after all expenses have been deducted from
sales. The measurement reveals the amount of profit that a business can extract from its total
sales. The net sales part of the equation is gross sales minus all sales deductions, such as sales
allowances. The formula is:

(Net profits ÷ Net sales) x 100 = Net profit margin

This measurement is typically made for a standard reporting period, such as a month, quarter, or
year, and is included in the income statement of the reporting entity.

The net profit margin is intended to be a measure of the overall success of a business. A high
net profit margin indicates that a business is pricing its products correctly and is exercising
good cost control. It is useful for comparing the results of businesses within the same industry,
since they are all subject to the same business environment and customer base, and may have
approximately the same cost structures.

Generally, a net profit margin in excess of 10% is considered excellent, though it depends on
the industry and the structure of the business. When used in concert with the gross profit
margin, you can analyze the amount of total expenses associated with selling, general, and
administrative expenses (which are located on the income statement between the gross margin
and the net profit line items).

However, the net profit margin is subject to a variety of issues, which include:
 Comparability. A low net profit margin in one industry, such as groceries, might be acceptable,
because inventory turns over so quickly. Conversely, it may be necessary to earn a high net
profit margin in other industries just in order to generate enough cash flow to buy fixed assets
or fund working capital.

 Leveraged situations. A company may prefer to grow with debt financing instead of equity
financing, in which case it will incur significant interest expenses, which will drive down its net
profit margin. Thus, a financing decision impacts the net profit margin.

 Accounting compliance. A company may accrue revenue and expense items to be in compliance
with various accounting standards, but this may give an incorrect picture of its cash flows.
Thus, a large depreciation expense may result in a low net profit margin, even though cash
flows are high.

 Non-operating items. The net profit margin can be radically skewed by the presence of
unusually large non-operating gains or losses. For example, a large gain on the sale of a division
could create a large net profit margin, even though the operating results of the company are
poor.

 Short-term focus. Company management could deliberately cut back on those expenses that
impair the ability of the business to compete over the long term, such as equipment
maintenance, research and development, and marketing, in order to increase the net profit
margin. These expenses are known as discretionary expenses.

 Taxes. If a company can apply a net operating loss carryforward to its before-tax profits, it can
record a larger net profit margin. Alternatively, management might attempt to accelerate the
recognition of non-cash expenses in order to minimize the amount of tax liability that it must
record in the current period. Thus, a specific tax-related scenario can significantly impact the
margin.

PTOP
 measures the speed with which a company pays its suppliers. If the turnover ratio declines from
one period to the next, this indicates that the company is paying its suppliers more slowly, and
may be an indicator of worsening financial condition.

 Payables turnover is an important activity ratio, and provides a measure of how

effectively a business is managing its payables.
 The payables turnover ratio measures the number of times the company pays off all its
creditors in one year.
 For example, a payables turnover ratio of 10 means that the payables have been paid 10
times in one year. A variant of payables turnover is number of days of payables. Number
of days of payables of 30 means that on average the company takes 30 days to pay its
creditors.