Profit margin in an economy reflects the profitability of any business and enables relative comparisons between small and large businesses. It is a standard measure to evaluate the potential and capacity of a business in generating profits. These margins help business determine their pricing strategies for goods and services. The pricing is influenced by the cost of their products and the expected profit margin. pricing errors which create cash flow challenges can be detected using profit margin concept and prevent potential challenges and losses in an entity.
Profit Margin is also used by businesses and companies to study the seasonal patterns and changes in the performance and further detect operational challenges. For example, a negative or zero profit margin indicates that the sales of a business does not suffice or it is failing to manage its expenses. This encourages business owners to identify the areas which inhibit growth such as inventory accumulation, under-utilized resources or high cost of production.
Profit Margins are important whilst seeking credit and is often used as collateral. They are important to investors who base their predictions on many factors, one of which is the profit margin. It is used to compare between companies and influences the decision of investment in a particular venture. To attract investors, a high profit margin is preferred while comparing with similar businesses.