How To Calculate Profit Margin

MileIQ

How do you know if your business is profitable? One indicator is your profit margin. This measure of profitability considers your gross, operating or net profit as a percentage of revenues. But how do you calculate these ratios? Read on to learn how to calculate profit margin.

How to Calculate Profit Margin: A Formula

There are three types of profit margins: gross, operating and net. All three are calculated by dividing the profit (revenue minus costs) by the revenue. Multiplying this figure by 100 gives you your profit margin percentage. However, each profit margin is calculated using a different measure of profit.

Gross Profit Margin

Gross Profit Margin is an indicator of profits relative to production costs. This type of profit margin is calculated based on gross profit. Gross profit represents your total revenue minus the cost of goods sold. This covers the cost of producing goods and can range from materials to labor.

Say you pay $8,000 for goods and sell them for $10,000. Your gross profit is $2,000. Divide this figure by the total revenue to get your gross profit margin: 0.2. Multiply this figure by 100 to get your gross profit margin percentage: 20 percent.

Operating Profit Margin

Overly high operating costs can impact your operating profit margin. Operating profit represents total revenue minus the cost of goods sold, operating expenses, amortization and depreciation. These expenses include many day-to-day expenses of running a business. They can range from overhead to administrative expenses.

Let’s factor operating costs into the previous scenario to calculate the operating profit margin. In addition to the $8,000 you paid for the cost of goods, say you paid an extra $500 in operating expenses. Deduct $8,500 from your total revenue and you get an operating profit of $1,500. Divide this by your total revenue to get your operating profit margin: 0.15. Multiply this figure by 100 to find the operating profit margin percentage of 15 percent.

Net Profit Margin

How well does your business turn revenues into profit? Look at your Net Profit Margin, an indicator of overall profitability calculated based on net profit. Net profit factors in more deductions from revenue than either gross or operating profit. It equals total revenue minus the cost of goods sold, operating expenses, interest, taxes, preferred stock and debt repayments.

Say your total revenue is $10,000 but you paid $8,000 for goods, $500 in operating expenses and another $500 in interest payments. Your net profit in this scenario amounts to $1,000. Divide this figure by the total revenue and you get your net profit margin: 0.10. Multiply this figure by 100 to get your net profit margin percentage: ten percent.

As you can see, the ratio of profit to revenue can vary depending on the type of profit chosen for the profit margin calculation. No profit margin alone can provide a complete picture of the financial health of your business. But learning how to calculate profit margin can show you where to adjust your business strategy.

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