How to Determine Your Business Profit Margin in 3 Simple Steps

profit margin formula

To grow a business, you need to track financial information and measure performance. One metric to watch out for is the profit margin of the business. Read on to find out how to determine profit margins for companies and ways to increase your margins.

What is Profit Margin?

Before you can determine your profit margin, you need to know what it is. Business profit margin is a metric for measuring the percentage of revenue that a business keeps after paying for expenses and expenses. You can calculate the profit margin to see the profitability for a certain period.

In short, the profit margin or percentage of the business lets you know how much profit the business is making for each item sold. For example, a profit margin of 40% means that you have a net profit of $ 0.40 for each sale.

Tracking the profit margins on your business can help you monitor the health of your company and make better business decisions in the future.

Not to mention, it can help businesses pinpoint and resolve financial problems faster. And, a gooood profit margin make your bussiness more attractive to investors.

There are several ways to look at the profit margins in a business:

  • Net profit margin
  • Gross profit margin
  • Operating profit margin

 Net profit margin

Your net profit margin, also known as your profit, is the total amount of revenue that remains after all expenses and income have been calculated.

This is the overall profit margin or net profit of the business. Your net profit margin shows up after deducting things like your cost of goods sold (COGS), operating expenses, debt payments, taxes, one-time payments, and investment income.

The net profit margin shows the overall ability of the business to turn revenue into profit. In most cases, the business can use the net profit margin to determine the profitability of the company and measure how much profit your business is making on the total operating revenue.

To calculate the net profit margin for your business, use the following formula:

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

If you have no net income, you can also use the formula below to calculate your profit margin:

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

Gross profit margin

Gross profit margin measures the income remaining after calculating COGS. Your gross profit margin does not include overheads, such as utilities or rent.

Gross profit margin is one of the simplest profitability metrics because it determines profit as the revenue left after you take the cost of goods sold into account.

Typically, the gross profit margin equation is used to determine the profit margin of a single service or product, which allows you to see the amount of revenue you save on each item and is not used to calculate the profit margin for the business as a whole.

You can use the gross profit margin to tell you which items are the most profitable and which are the least profitable.

So, how are you going to calculate your gross profit margin? To determine the gross profit margin, use the following formula:

Gross Margin = {(Total Income - HPP) / Total Income} X 100

Operating profit margin

The operating profit margin takes into account all overhead, operating, administrative, and sales costs required for day-to-day business operations.

However, it does not include payables, taxes, and other non-operating expenses. Your operating margin will show you the income from operating activities.

To find the operating profit margin for your business, use the formula below:

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

How to Determine the Profit Margin in 3 Steps

As you know, there are several ways to determine your profit margin. However, this depends on the type of profit margin you want to calculate.

To determine your company's overall profit margin, you will want to use the net profit margin formula. Use the formula below to calculate the overall profit margin for your business:

Profit Margin = (Income / Net Income) X 100

If you want to easily enter information into the above formulas, use these three steps to determine your profit margin:

  • Determine your business's net income (Revenue - Expenses)
  • Divide your net income by your revenue (also called net sales)
  • Multiply your total by 100 to get your profit margin percentage

Example of Calculating Profit Margin for a Business

Ready to see how to calculate profit margins in real cases? Take a look at some of the examples below on how to calculate net / overall profit margins as well as gross and operating margins.

Example 1: Net profit margin

For this example, let's say you don't know what your business's net income amounts to. Since you don't know the amount of net income, use the following formula:

Net Profit Margin = {(Income - COGS - Operating Expenses - Other Expenses - Interest - Taxes) / Income} X 100

To find your net income, follow the first part of the formula, which subtracts various expenses from your income. Here is a breakdown of the costs that you must deduct from your income:

COGS: 4,000,000
Operating costs: 3,000,000
Other expenses: 1,500,000
Interest: 500,000
Tax: 1,000,000

Your total spend has increased to 10,000,000

Your income is 20,000,000.

Plug your total into the formula from above to find your net profit margin.

[(20.000.000 – 4.000.000 – 3.000.000 – 1.500.000 – 500.000 –  1.000.000) / 20.000.000] X 100

[( 20.000.000 –  10.000.000) / 20.000.000] X 100

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

If you already know your net income amount, you can skip the step of subtracting your expenses from income and simply divide your net income by your income, then multiply the total by 100 (see other net profit margin formulas listed below).

Example 2: Gross profit margin

Let's say you want to find the gross profit margin on a particular product that you offer. To find your gross profit margin, you need to know how many items were sold for (revenue) and how much it costs to make the product (COGS).

Suppose you sell clothes for 25,000. It costs 15,000 dollars to make a t-shirt (HPP). To find your gross profit margin, plug your total into the formula below:

Gross Margin = [(Total Income - HPP) / Total Income] X 100

Margin Kotor = [(25.000 – 15.000) / 25.000] X 100

Your business's gross profit margin is 40%, or 0.40. This means you make 40% on every shirt you sell.

Example 3: Operating profit margin

Let's say you want to find the operating profit margin for your business. Your operating income is 10,000,000 and your income is 40,000,000. Enter your operating information into the operating profit margin formula.

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

Operating Profit Margin = (10,000,000 / 40,000,000) X 100

Your company's operating profit margin is 25% or 0.25.

Standard Profit Margins in Various Industries

Profit margins vary from industry to industry. A “good” profit margin for one company can be considered “bad” for another.

Your average profit margin depends on several different factors. Some of these factors include the number of employees you have, your business location, type of business, size, how you manage your inventory, and your operating system.

How to Increase Business Profit Margins

Does your profit margin need to improve a little? If so, don't worry… you are not alone.

If you want to increase the profit margins of your business, you may need to make some adjustments. Ultimately, the thing to do is lower costs and expenses and increase sales to increase margins in the business.

To help lower costs, you can:

  • Optimize vendor relationships
  • Look for alternative solutions for the current process
  • Cut unsuccessful bids or sell
  • Reducing business and operating costs
  • Identify and eliminate things that interfere with profit growth

If you want to increase sales, consider doing the following:

  • Make sales on old stock
  • Raise your price accordingly
  • Use upselling and cross-selling techniques
  • Increase customer retention
  • Increase inventory visibility

Conclusion

Is that the definition and several ways to find out the profit margin of your business? Having trouble calculating margins and doing manual bookkeeping? You can try using accounting software for simplicity and better process.

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