What is profit margin?
Profit margin indicates the profitability of a product, service, or business. It’s expressed as a percentage; the higher the number, the more profitable the business is.
To calculate profit margin, you need to take the formula for profit and divide it by the revenue. The profit margin formula is: ((Sales — Total Expenses) ÷ Revenue) x 100
There are three types of profit margins:
- Gross profit margin
- Net profit margin
- Operating profit margin
What is the gross profit margin?
Gross profit margin usually applies to a specific product or line rather than an entire business. It displays how much profit each product creates without fixed costs.
Calculating the gross profit margin helps a business determine pricing decisions. A low gross profit could mean that the company needs to charge more to make it worth selling a specific product.
The gross profit margin formula is: (Gross Profits ÷ Net Sales) x 100
Note that the cost of products sold includes direct product costs but doesn’t include indirect costs, such as rent, office supplies, and so on.
What is the net profit margin?
Net profit margin is a calculation that expresses the profitability of an entire company, not just a single product or service. It is also expressed in a percentage; the higher the number, the more profitable the company.
The net profit margin formula is: Net Profit ÷ Total Revenue x 100
When calculating a net profit margin, keep in mind your industry. Industry characteristics vary so much that it’s unrealistic to expect a restaurant to be comparable to an auto parts retailer.
What is the operating profit margin?
Operating profit margin includes both costs of goods sold, costs associated with selling and administration, and overhead.
The operating profit margin formula is: ((Revenues + Cost of Goods Sold — Selling and Administrative Expenses) ÷ Revenues) x 100