What is profit margin?
Before you can dive into determining profit margin, you need to know what it is. Your business’s profit margin measures what percentage of revenue your business keeps after paying for outgoing expenses. You can calculate profit margin to see profitability for a specific time period.
In short, your profit margin or percentage lets you know how much profit your business has generated for each dollar of sale. For example, a 40% profit margin means you have a net income of $0.40 for each dollar of sales.
Tracking your profit margin can help you monitor your company’s health and make better business decisions in the future. Not to mention, it can help you flag and resolve financial issues more quickly. And, a good profit margin can make your business more attractive to investors.
There are a few ways to look at your profit margin:
- Net profit margin
- Gross profit margin
- Operating profit margin
Net profit margin
Your net profit margin, also referred to as your bottom line, is the total amount of revenue left over after all expenses and income is accounted for. This is your overall or “regular” profit margin. Your net profit margin looks at things like your cost of goods sold ,operational expenses, payments on debts, taxes, one-time payments, and any income from investments.
Net profit margin shows your business’s overall ability to turn income into profit. In most cases, you use net profit margin to determine your company’s profitability and measure how much profit your business generates of your total revenue.
To calculate your business’s net profit margin, use the following formula:
Net Profit Margin = (Net Income / Revenue) X 100
If you don’t have your NET INCOME handy, you can also use the profit formula below to calculate your profit margin:
Net Profit Margin = [(Revenue – COGS – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue] X 100
Gross profit margin
Gross profit margin measures the income left over after accounting for COGS. Your gross profit margin excludes overhead expenses, such as utilities or rent. Gross profit margin is one of the simplest profitability metrics because it defines profit as the income remaining after you account for cost of goods sold.
Typically, the gross profit margin equation is used to determine the profit margin of a single service or product, allowing you to see the amount of revenue you keep on each item. It is not usually used for calculating the profit margin for the business as a whole. You can use gross profit margin to tell you which items are the most and least profitable.
So, how do you calculate gross profit margin? To determine gross profit margin, use the following formula:
Gross Margin = [(Total Revenue – COGS) / Total Revenue] X 100
Operating profit margin
Operating profit margin takes into account all overhead, operating, administrative, and sales expenses necessary for day-to-day business operations. However, it does not include debt, taxes, and other non-operational expenses. Basically, your operating margin will show you your earnings from operating activities.
To find your business’s operating profit margin, use the formula below:
Operating Profit Margin = (Operating Income / Revenue) X 100
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