Businesses use a number of different financial ratios to indicate how much money they are making. Two of the most common of these ratios are the profit margin and the payout ratio. The profit margin is a calculation of how profitable a company is and generally takes the form of a ratio of total profits to revenue. A payout ratio is the ratio of earnings -- or profits -- per share to dividends to per share.
A profit margin is a measurement of how much money a company made in relation to how much business it did. Generally, it is the ratio of the profits the company made to the total amount of revenues it took it. Some companies, such as grocery stores, have extremely small profit margins -- often as little as 1 percent -- while other companies, such as oil companies, can enjoy enormous profit margins.
The payout ratio is the ratio used by companies with publicly traded stock that issue dividends. Each quarter, the company must decide how much it will pay out in dividends. Each share receives the same amount of dividends. By dividing this number by the company's earnings per share -- the total company's earnings over a set period of time, divided by the total number of shares -- an investor arrives at the payout ratio.
Both the profit margin an the payout ratio involve a company's profitability. With a profit margin, an investor can get an estimate of how profitable a company is relative to how much business it does. With a payout ratio, am investor can determine how much money it will likely receive from the company in the form of dividends as compared to the profits it makes.
While both these measurements can be helpful to an investor considering whether to purchase stock in a particular company, they look at very different aspects of a company. A profit margin gives a rough estimate of how close to the bone a company is riding in terms of profitability. A payout ratio gives a hint of how much of this profit the company is going to be passing back to investors.
- "Business Management: Fresh Perspectives"; S. Goodman; 2007