How do you know if youthe business is profitable? One indicator is your profit margin. This profitability measure considers your gross, operating, or net profit as a percentage of revenue. But how are these indices calculated?
To demonstrate this, we explain how to calculate the profit margin.
What is a profit margin?
A profit margin expresses how much of every dollar of sales a company keeps in its profits. At the same time, you factor in customer service costs to find the true profit.
A formula for calculating profit margin
There are three types of profit margins: gross, operating and net. You can calculate all three by dividing profit (revenue minus costs) by revenue. Multiplying this value by 100 gives you your profit margin percentage. In each case, calculate each profit margin using a different profit measure.
gross profit margin
Gross profit margin is an indicator of profit relative to production costs. Then calculate your profit margin based on gross profit. Gross profit represents your total revenue minus cost of goods sold. As a result, this amount covers the cost of producing goods and can range from materials to labor.
For example, let's say you pay $8,000 for merchandise and sell it for $10,000. Your gross profit is $2,000. Divide that amount by total revenue to get your gross profit margin: 0.2. Multiply this figure by 100 to get your gross profit margin percentage: 20%.
Proceeds from the sale of goods - Cost of goods = Gross profit margin.
operating profit margin
Operating costs that are too high can affect your operating profit margin. So your operating profit is your total revenue minus your business expenses.
They arebusiness expensesinclude:
- cost of goods sold
- operational expenses
- administrative expenses
- Otherdaily operating expenses of a company
Let's consider the operating costs in the above scenario to calculate the operating profit margin. Also, let's say you paid an additional $500 in operating expenses on top of the cost of the products.
Deduct $8,500 from your total revenue and you have an operating profit of $1,500. Then divide that by your total revenue to get your operating profit margin: 0.15. Then multiply that value by 100 to find the 15% operating profit margin percentage.
net profit margin
How well does your company turn revenue into profit? see younet profit margin. This assessment is an indicator of overall profitability calculated on the basis of net income.
Net income takes into account more deductions from revenue than either gross profit or operating profit. In short, it equals total revenue minus cost of goods sold, operating expenses, interest, taxes, preferred stock, and debt payments.
Let's say your total income is $10,000, but you've paid $8,000 in assets, $500 in operating expenses, and another $500 in interest payments. Now your net profit in this scenario is $1,000. Divide that amount by total revenue and you get your net profit margin: 0.10. Then multiply that number by 100 to get your net profit margin percentage: ten percent.
As you can see, therelationship between profit and revenuemay vary depending on the type of profit chosen for calculating the profit margin. No profit margin alone can provide a complete picture of your business's financial health. But learning how to calculate markup can show you where to adjust your trading strategy.