Profit Margin Calculator and Formula

If you’re an entrepreneur you may need to calculate the profit margin of your business to get investment, or to measure the financial health of your company. This guide covers the different ways to figure out profit margin, and also provides some helpful tools for convenience.

We’ll also take a look at how you can cut the costs of business with a Wise business account - giving your profits a boost at the same time.

What is Profit Margin?

Profit margin is a commonly used business metric which shows how much of a company’s earnings remain as profit, once all expenses have been paid.

Profit margin is expressed as a percentage. If a business reports a profit margin of 20%, this means that 20 cents from every dollar of sales is profit. The remaining 80 cents has gone to cover normal business expenses such as the costs of goods, employee payroll, overheads and taxes.

It’s worth noting that there are several different ways to calculate profit margin. We’ll cover the different formulas used in this guide - but usually when someone refers to profit margin they mean net profit margin. That calculation looks at the profit left once all expenses have been accounted for.

Here’s what this guide will cover:

• How to calculate Profit Margin?
• Gross profit margin
• Net profit margin
• What is a good profit margin?

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How to calculate Profit Margin?

Profit margin can be calculated in 4 different ways, depending on the information required. The figures you come up with will look at either:

• Gross profit margin
• Operating profit margin
• Pretax profit Margin
• Net profit margin

Each calculation has its own uses, and business owners, investors and analysts might need to use the different formulas at different times.

In simple terms, gross margin is what is left when you subtract the direct costs of goods from the total amount of sales. If you then also remove the price of indirect costs like running an office, paying administrative staff or advertising, what remains is operating profit.

The next line is pre-tax profit, which is calculated by taking operating profit, and removing one off charges and interest paid on debts, as well as adding in interest received on investments, and any one off gains.

Finally, the business’ taxes must be paid - which leaves the net profit. This is also known as net income - or the bottom line, as it’s literally the last line on a profit and loss statement.

Gross Profit Margin

Gross profit margin calculations start with the amount a company earns from sales, and then remove the cost of goods sold (also called cost of sales).

Cost of goods sold (COGS) means any expenses directly involved in creating the product or service being sold. That might be the cost of the raw materials used to make a product, as well as the amount paid to the worker making it, for example.

To calculate the gross profit margin you use the following calculation:

Gross profit margin = (Net sales - COGS) / Net sales x 100

The easiest way to work out the gross profit for your business is to use an online profit margin calculator. You can also use this handy spreadsheet to enter your company data and generate your gross profit margin.

Operating Profit Margin

Operating profit is also known as EBIT - earnings before interest and taxes. It’s a useful figure for investors to analyse the amount of money a company is making.

Operating profit margin starts by looking at the total sales a company has made, before removing the cost of goods sold, as well as the general or administrative costs a business needs to cover. The amount left over is known as operating income.

Here’s the formula to calculate operating profit margin:

Operating profit margin = Operating income / revenue x 100

Work out the operating profit margin for your business with an online calculator, or download our free excel based tool to make it easy.

Pretax Profit Margin

Pretax profit builds on the previous calculations. You’ll start with the sales of the company, and remove all of the costs and operating expenses. You then also account for any other costs, such as interest, or one off payments to or from the business. This leaves pretax profit, which is also known as EBT - earnings before tax.

Here’s how you calculate pretax profit margin:

Pretax profit margin = (Gross profit - (operating expenses + interest expenses)) / revenue x 100

Pretax profit calculations are popular because different companies may be taxed differently, making it tricky to compare their economic successes. Looking at their overall profitability before tax allows an analyst to see how well a business is doing without the complicating factor of tax.

Figure out the pretax profit for your business with this helpful spreadsheet.

Net Profit Margin

Net profit margin is one of the most commonly used financial calculations because it looks at how much profit a company can generate when all expenses, such as cost of goods, labor, advertising, property rental and taxes are taken into account.

To calculate net profit margin you need to know the company’s net profit and net sales. If you’re unsure of the net profit of the business, take the revenue - that is the total sales - and remove COGS, operating expenses, other expenses, interest and tax.

Here’s the calculation:

Net profit margin = net profit / net sales x 100

It’s worth noting that dividends paid aren’t considered in this formula because dividend payments are not considered an expense.

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Let’s look at an example:

If a business has made $50,000 in sales last month, but the total of all expenses incurred was $20,000, this is how you’d work out the net profit.

Net profit: 50,000 - 20,000 = 30,000

Net profit margin: 30,000 / 50,000 x 100 = 60%

In real terms this means that every $1 of sales resulted in $0.60 of retained profit.

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Work out your own business’ net profit with this online net profit calculator, or use our helpful spreadsheet. Enter your own business data to calculate your net profit easily online.

Gross Profit vs Net Profit: what is the difference?

You may be wondering which calculation is more useful - gross profit or net profit. Both have their place, and both are used by investors and entrepreneurs at different times.

Gross profit gives a fairly raw number. You’re looking at the revenue you get from sales of an item compared against the cost of making that item. However, that doesn’t tell the whole story, as there are always extra costs involved with running a business, such as marketing and tax. That’s where net profit comes in - giving a fuller picture of the way a business works.

As a business owner you might like to look at the gross profit margin of one potential product versus another, for example. This could help you decide which you’d rather sell.

If you’re an investor, on the other hand, you’ll likely want to know about the net profit margin if you’re comparing two businesses to decide which to invest in.

What is a Good Profit Margin?

Unfortunately, there’s no simple answer to the question - what is a good profit margin?

Profit margins are influenced by a lot of different factors, and so can vary widely between industry and company type. If you’re interested in evaluating the profit margin you’ve calculated for your business, you can start by comparing your company to others in the same field.

There’s also a range of interesting and useful data available online to help you. For example, New York University ran a study on profit margins across different industry types, to give you a broad benchmark³.This research shows how much the level of profit margin can differ. A company selling clothes may be making a net margin of just under 6%, whereas an information services business hits closer to 20% in net margin.

Either company might be considered successful against similar businesses - even though the respective net profits are very different.

If you’re not sure what a good profit margin looks like for your business, do some research into companies in your industry sector and local area, and get professional advice if you need it.

How to improve Profit Margin?

Understanding how profit margin is calculated is the first step to driving a more profitable business. Here are a few ideas of how to improve your company’s profit margin.

Decrease expenses

By cutting your costs, including COGS, overheads and operational expenses, you can protect and grow your profits.

Cut underperforming products or services

Reviewing the profitability of each product or service you provide is a smart way to optimize your business. Analyze which products work well and offer the best returns, before cutting out products which don’t make the grade.

Increase product offerings or services

After analyzing the products and services you offer, you may notice that a certain category is especially successful, or driving a large slice of your profit. Use this knowledge to develop your product range to make the most of your profits.

Increase pricing

Increasing your profit margin means growing your sales, cutting your expenses - or both. By increasing your pricing, you may be able give your top line revenue a boost, and improve your profitability.

Don’t forget that driving improvements in profit margin is a balancing act. You want to cut your costs - but if you go too far, you’ll damage your business. You want to increase your prices - but push up the costs too much, and you may start to lose customers. Play with the levers you have to hit the right balance for your business and continue to grow the net profits you can achieve.

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Let’s take a look at a few key points to summarize:

• Profit margin is a measure of how much your business is earning compared to the expenses involved with creating, marketing and selling goods.
• You’ll often see percentage margin figures, which basically represent the amount of profit in cents made for every dollar of sales revenue - a 20% margin means you get $0.20 profit for each $1 of sales, for example.
• Net profit margin gives the fullest picture of how a business is doing, and is the most commonly used calculation.
• What a good profit margin looks like varies widely from industry to industry. Entrepreneurs, investors and analysts use profit margin data to compare one business to another, and measure the financial health of a company.
• Grow your net profit margin by increasing sales and decreasing expenses.
• You can cut your costs - and manage your finances more conveniently - with a Wise business account

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Sources:

1.Investopedia: Profit Margin Definition
2.Investopedia: Pretax Profit Margin
3.NYU: Operating and Net Margins

Sources checked: 18-February 2020.