If you’re like most small business owners, you’re probably constantly looking for ways to cut costs and increase your revenue. But how do you actually determine the profitability of your business? By using the correct profit margin formula, you’ll be able to quickly get an accurate look at the state of your company finances.
We’re defining all of the important terms you’ll need to know and breaking down how to find out what your company profit margin is. If you don’t have a handle on the numbers you’ll need to use these profit margin calculations you may want to seek out an accountant to help. Then we’ll compare the profit margins in a variety of industries and give you some great tips on how your business decisions can improve your profit margin percentage and bottom line.
What is a profit margin?
Before we get started, it’s important that any small business owners understand what a profit margin is and what it means for their company. Essentially, a profit margin is a tool that you can use to figure out how profitable your business is and how efficiently your resources are being used, in the form of a percentage. The various formulas to determine your profit margins take into account things like revenue, cost of goods, and operating expenses. By plugging these numbers into the correct formula, business owners can understand how their net income relates to their overall revenue. In general, the higher your profit margin is, the more money your company is making.
Profit margin formula
Multiple different formulas can be used to determine the profitability of your company. Before we get into the specific equations and how they relate to your business, let’s take a closer look at the basic profit margin formula and what information you need to take from your income statement in order to calculate it.
Profit margin = (gross margin – expenses)
Gross margin refers to your earnings after the costs of production, including expenses like supplies, equipment, and labour. Expenses refer to the costs your company incurs after production and includes things like rent, employee salaries, and marketing costs.
When you subtract your expenses from your gross margin, you end up with a number that represents how much of the money your company made in revenue is being retained after all of your expenses.
Profit margin example
To help illustrate how the profit margin equation can be used in practice, let’s use a sample business and calculate their profit margin.
Your real estate construction company has a total revenue of $150,000 yearly. The cost of production-related goods, including building materials and equipment, comes to $50,000, making your gross profit margin $100,000. Your operating expenses, including paying your construction workers and real estate agents, rent, and taxes come to $40,000. Let’s plug those numbers into the equation to figure out your profit margin.
Profit margin = ($100,000 – $40,000)
Profit margin = $60,000
What are the different types of profit margin?
Depending on what specific information you’re looking for, there are a few different formulas for calculating profit margins. We’ll explain in depth what each equation is for and how to use them in your business.
Gross profit margin
Gross profit margin = ((revenue – COGS) / revenue) x 100
Cost of goods sold (COGS) includes any expenses associated with the production and manufacturing of your product, including all materials and labour. COGS does not include any costs to your business that occur after production.
The gross profit margin equation is often used by businesses to determine a single product’s profitability instead of the company’s overall profitability.
For example, let’s imagine that you design and sell mugs for $20, and they cost you $5 to make.
Gross profit margin = (($20 – $5) / $20) x 100
This leaves you with a gross profit margin of 75 per cent, meaning you retain 75 per cent of every dollar that you make after subtracting COGS, but not including operating costs after production.
Operating profit margin
Operating profit margin = (operating income / revenue) x 100
This formula considers all operating costs after production, including rent, salaries, and day-to-day company operations, to determine the percentage of each dollar that your business retains after all expenses (excluding any debt repayment, taxes, and non-operational expenses).
For example, you run a small business operating outpatient care centers. Your operating income is $60,000, and your revenue is $100,000.
Operating profit margin = ($60,000 / $100,000) x 100
According to the operating pro