Editor's Note: This article is part of Inc.'s bi-weekly primer on business terms in partnership with financial information company Sageworks

You walk into your accountant’s office, and she hands over your annual income statement for your business. You give a quick glance to the page--all the familiar numbers are there--but you focus on one in particular: Net income. 

There are plenty of ways to gauge success. Today it’s a smile or a frown, depending on how that number turns. For all the changes in the way business has been conducted through the years, success is still judged by whether or not it’s profitable. Net income determines your personal salary, how much you have to expand your operations, hire more people and invest in more equipment--in short--everything.

However, profit alone doesn’t tell you the whole story. To gain a deeper understanding of your company’s performance, you should also examine your net profit margin.

Why profit margin is important

Net profit margin (net income divided by sales, expressed as a percentage) tells you how much your company is actually earning for each dollar in sales. It takes into account all expenses, so it is a true measure of profitability, and it also gives a temperature check on how efficiently you’re running and scaling your business. All of the revenue growth in the world means little without real earnings (and cash flow).

You cannot look at net profit in isolation, because it doesn’t necessarily increase and decrease in unison with your profit margin. For example, let’s say you make $1 in profit from $10 in sales in 2012, and $200 in profit on $4000 in sales in 2013. Your net profit skyrocketed ($1 to $200 in profit), but your profit margin declined to 5% from 10%. You’re generating more profit, but your business isn’t being scaled as efficiently as it could be.

Managing your profit margin is important for generating your desired bottom-line outcomes. Without monitoring your profit margins, your profits may shrink even as your sales rise, or--with proper oversight--you may be able to increase your profits even if your sales slump.

Compare profit margin across time

Your current profit margin, by itself, can tell you surprisingly little. So let’s do some comparisons. The first comparison to make is to your own business. Bring out your old income statements from the previous few years, and calculate the profit margin for each of these years (assuming, of course, that you’ve been in business for a while).

Once calculated, place the numbers side by side in chronological order. Determine whether your profit margin (not just your profit) is increasing, decreasing or staying the same; and determine if the year-to-year changes are accelerating or decelerating. If your margins are ‘bad’ (i.e. decreasing), you will need to analyze your revenues and expenses closely to determine which line items, in particular, are contributing to the decrease. Increased competition or the economy as a whole may be to blame if you can’t pinpoint the culprit. On the other hand, ‘good’ margins can tell you that you’re previous efforts to cut costs or increase sales have been successful.

After you have compared your own profit margins across time, you should compare your current margin to your industry’s average--a process known as benchmarking. If you can’t find this information online, your accountant or financial professional might have access to it. Or, through their experience, they might have a general understanding of the typical profit margin for your industry. You can also compare your profit margin to those of public companies in your same industry if you can’t find private company data.

Knowing the average profit margin for your industry can be eye-opening. If your profit margin is lower than the industry average, you can use this information to your advantage. It may indicate that your revenue is too low or your costs are too high, and this knowledge can give you the confidence to change suppliers, raise prices, or reign in overhead costs. If your profit margin is higher than the industry average, you can feel validation that what you’re doing is effective--keep at it!

Your current profit margin might not mean much by itself, but comparing it to those from years past or industry averages will help you determine whether your profitability is good or bad. Managing this ratio is crucial to achieving your profit and company goals. A few high profile tech companies have managed to grow and scale without being profitable, but these companies are the exception not the rule.

In the end, profits tell you what you want to hear, namely, how much you’ve made. Profit margins tell you what you need to know about prospects for the future.