Profit Margin: Formula and How to Calculate

Profit margin is a measure of how many cents of profit is generated per dollar of sale. Displayed as a percentage, profit margin shows how much money a business makes and is used to compare and assess business performance. Here are the types of profit margin and formulas for how to calculate profit margin.

How do you calculate profit margin?

To calculate a profit margin, you’ll need to have a few numbers on hand. You should know revenue and costs. Revenue is the total amount of money generated; costs are what the company paid to do business.

You can change exactly what you include in your revenue or cost numbers to look at different types of profit margins, which you can use for different purposes.

Net profit margin

Net profit margin shows how much money the company made after all expenses are paid, including taxes. While there are multiple ways to calculate profit margin, the most commonly used is net profit margin, as it measures a company’s bottom line.

To calculate net profit margin, your revenue and costs should include absolutely every dollar that comes out of and goes into the company.

Gross profit margin

Gross profit margin is useful when you want to look at the profitability of a particular product or service.

When measuring gross profit margin, the revenue should be the amount of money produced by the sale of only that particular product or service. The costs should include only the direct costs associated with producing that same product or service. These are also referred to as the cost of goods sold (COGS) or variable costs.

For example, in a small business bakery, the COGS of a single cake would be the cost of the ingredients and the labor. It wouldn’t include the bakery’s rent or the price of the industrial oven.

Operating profit margin

Operating profit margin shows how much money the company is making from its basic operations — not including any taxes, loan payments, loan interest or unusual one-time events like a lawsuit. For this reason, operating profit margin is typically useful during mergers and acquisitions or when buying an existing business.

In this case, the revenue is the company’s total revenue except for interest earnings from any loans the company provided. The costs are the operation costs: labor, materials, administrative and advertising. Subtracting operation costs from total revenue (minus interest earnings) is also called operating income or the company’s earnings before interest and tax (EBIT).

Pretax profit margin

The pretax profit margin shows how much a company makes before Uncle Sam steps in. You can compare this to your net profit margin to see how taxes influence your bottom line. It’s another way to look at the business’ operating efficiency.

The revenue is the company’s total revenue and the costs are all costs except taxes. The dollar amount you get is also called earnings before tax (EBT).

What is a profit margin example?

Here’s an example of profit margin for a hot dog stand.

First, let’s add up the total costs:
$30,000 + $15,000 = $45,000

Then, we can plug in the numbers into the profit margin formula shown above:
(($50,000 – $45,000) / $50,000) x 100 = 10%

The business of Mike’s Hot Dog Stand had a 10% net profit margin last June.

Absolute numbers — like $5 million or $100,000 — don’t necessarily show the company’s health. If a company made $5 million in a year, but spent $4,999,900 to do it, the profit margin is low and the company is likely unsustainable. On the flip side, if a business spent only $45,000 to generate $50,000, the business may be a good investment.

What is a good profit margin?

Generally, the higher the profit margin, the better. Factors that can influence your company’s goals and performance include its:

• Industry
• Physical location(s)
• Online location(s)
• The time of year
• Employees
• Equipment
• Market demand

Profit margin vs. markup

The profit margin is influenced by the markup, which is how much the cost of a good or service is increased.

For example, if a car dealer pays $20,000 to buy a vehicle and then sells the car for $25,000, the markup is $5,000. The markup is not necessarily pure profit. The profit margin on the car is likely reduced by costs like cleaning and advertising the vehicle, the salesperson’s commission and the dealer’s overhead, such as the rent or mortgage on the car lot, among other items.

What are some profit margin benchmarks?

Here are some examples of high and low profit margin industries, including a smattering of the 11 most profitable small businesses you could start. Admittedly, some of the ranges are quite wide as the costs of a plumbing company in Brooklyn, N.Y. may look very different from one in more rural Bozeman, Mont.