Profit Margin: How To Calculate Profit Margin For Your Small Business

If you want to grow your business, then you need to monitor financial data and measure performance. One metric you should pay more attention to is your business’s profit margin. This article covers how to find your company's profit margin and ways to improve your margins.

What is meant by profit margin?

Before you can learn how to calculate profit margin, you need to know what it means first. A company's profit margin measures what percentage of revenue it retains after paying for outgoing expenses. You can use it to check a company's profitability for a specific period either monthly, quarterly or yearly.

Furthermore, your profit margin enables you to know how much profit your business makes for each dollar of sale. For instance, a 50% profit margin means you have a net income of $0.50 for each dollar of sales.

Keeping track of your profit margin can help you check your company’s health and make good business decisions in future. It can also help you identify and resolve financial problems more quickly. And, a good profit margin can attract more investors to your business.

There are a three ways to calculate your company's profit margin, they are;
  1. Net profit margin
  2. Gross profit margin
  3. Operating profit margin

1. Net profit margin

Also called your bottom line, net profit margin is the total revenue left over after all income and expenses are accounted for. This is your main or “regular” profit margin. It considers items like your cost of goods sold (COGS), operational expenses, payments on debts, taxes, and any income from investments.

Furthermore, net profit margin shows your business’s overall ability to turn income into profit. In most cases, you can use it to find out your company's profitability and measure how much of your total revenue is profit.

Net profit margin formula

Net Profit Margin = (Net Income / Revenue) X 100

Net income is calculated from the company's income statement, however, if you don’t have your it at hand, you can also use the formula below to calculate your net profit margin:

Net Profit Margin = [(Revenue – COGS – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue] X 100

You can read also our comprehensive and detailed article on net income margin

2. Gross profit margin

Gross profit margin calculates the income left over after deducting cost of goods sold (COGS). It excludes overhead expenses like utilities or rent. Gross profit margin is one of the simplest profitability measures because it determines profit as the income remaining after accounting for cost of goods sold.

Profit Margin: How To Calculate Profit Margin For Your Small Business

Normally, the gross income margin is used to determine the income margin of a single service or product, so you can see the amount of revenue you earn on each item. It doesn't determine the profit margin for the business. It tells you which items are the most and least profitable.

Gross profit margin formula

To find gross profit margin, use the formula below:

Gross Margin = [(Total Revenue – COGS) / Total Revenue] X 100

You can read also our comprehensive and detailed article on gross profit margin

3. Operating profit margin

Operating profit margin records all overhead, operating, administrative, and sales expenses necessary for daily business operations. However, it does not include debt, taxes, and other non-operational expenses. Basically, it indicates the earnings from operating activities.

Operating profit margin formula

Use the formula below to find your business's operating profit margin:

Operating Profit Margin = (Operating Income / Revenue) X 100

You can read also our comprehensive and detailed article on operating profit margin

How Do We Calculate Profit Margin?

As we have shown you, there are a few ways to calculate your company's profit margin. However, this depends on the type of profit margin (e.g., operating, gross, etc.) you want to calculate.

Profit Margin Formula

To find your company’s overall profit margin, it is advisable to use the net profit margin formula.

Profit Margin = (Net Income / Revenue) X 100

If you want to easily insert information into the profit margin formula, use these three steps:
  1. Determine your business’s net income by deducting total expenses from total revenue (Revenue – Expenses)
  2. The next step is to divide your net income by your revenue (net sales)
  3. Lastly, multiply your total by 100 to arrive at the profit margin percentage
Profit margin calculation: Examples

Take a look at some examples on how to calculate net profit margin as well as gross and operating margins.

Example 1: How To Calculate Net Profit Margin Percentage

For this example, assuming you don't know what your business’s net income is. Use the profit margin formula below since you don't know the net income amount:

Net Profit Margin = [(Revenue – COGS – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue] X 100

Follow the first part of the formula, which is subtracting various expenses from your revenue to find your net income. 

We illustrated the breakdown of the expenses you need to subtract from your revenue with an example:
  • COGS: $4,000
  • Operating expenses: $3,000
  • Other expenses: $1,500
  • Interest: $500
  • Taxes: $1,000
  • Revenue: $20,000. 
To find your net profit margin, all you have to do is to plug your totals in the example into the formula stated above

[($20,000 – $4,000 – $3,000 – $1,500 – $500 – $1,000) / $20,000] X 100

[($20,000 – $10,000) / $20,000] X 100

Your business's net profit margin is 50% or 0.50 [($10,000 / $20,000) X 100].

If you already have your net income amount at hand, you can just skip the step of deducting your expenses from revenue and simply go straight to dividing your net income by your total revenue, then multiply the result by 100.

$10,000 net profit / $20,000 revenue × 100 = 0.5 or 50%

Example 2: How To Calculate Gross Profit Margin Percentage

For example, say you want to find out the gross profit margin on a certain product you sell. Firstly, you need to know how much the item sells for (revenue or selling price) and how much it costs to make (COGS).

Say the cost of a pair of shoe is $25. It costs $15 dollars to produce the shoe (COGS). To calculate your gross profit margin, enter your totals into the formula below:

Gross Margin = [(Total Revenue – COGS) / Total Revenue] X 100

Gross Margin = [($25 – $15) / $25] X 100

Your business’s gross profit margin is 40%, or 0.40. This means for every shoe you sell, you make 40%.

Example 3: How To Calculate Operating Profit Margin Percentage

For instance, you want to find your business’s operating profit margin. Your operating income is $10,000 and your revenue is $40,000. Input your operating information into the operating profit margin formula.

Profit Margin: How To Calculate Profit Margin For Your Small Business

Operating Profit Margin = (Operating Income / Revenue) X 100

= ($10,000 / $40,000) X 100

Therefore, your company’s operating profit margin is 25% or 0.25.

What is a good profit margin?

Profit margins vary from industry to industry. A “good” profit margin for company X may be considered “bad” for company Y.

There are some factors that determine your average profit margin. Some of these factors include the number of employees on your payroll, business site, type of business, size of business, inventory management, and your operating systems.

What are the ways to improve profit margin? 

To increase your profit margin, you can just make a few changes and see how it work like magic. Ultimately, to improve your margin, just cut costs and expenses and increase your sales. To lower costs, you can do the following:
  1. Enhance vendor relationships
  2. Seek for alternative solutions to current processes
  3. Reduce inventories that don’t do well
  4. Reduce business and operating expenses
  5. Identify and cut waste
If you want to increase your sales, consider doing the following:
  1. Sell old inventory
  2. Increase your prices accordingly
  3. Apply upselling and cross-selling methods
  4. Increase customer retention
  5. Improve inventory visibility
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