In the business world, “profit margin” is one of the most commonly used ratios. It is the basic measurement of how much a business, product, or service is making. It’s typically expressed as a percentage and is how much the business makes per transaction. As a general rule, the higher the profit margin, the more profitable the business. Therefore, the profit margin is often used to determine the success of a business.
How to Calculate Profit Margin
There are different types of profit margins, but the equation typically involves two key metrics: business sales versus expenses. Generally, you can calculate profit margin by taking your sales and subtracting your expenses. You can use this metric to calculate profit margin for a certain period of time for certain products/lines. However, it’s important to note that the metric varies more with short time periods.
3 Types of Profit Margin
There are three types of profit margins:
We’ll look a little closer at each one of these below:
Gross Profit Margin
This is the income remaining after you account for the cost of goods sold, or COGS, which are expenses related to the production/manufacturing of the product. This includes wages, raw materials, and anything else involved. You will not include debt, taxes, overhead costs, or one-time expenditures, such as equipment purchases.
Gross Profit Margin equals Net sales minus cost of goods sold, divided by net sales times 100.
Net Profit Margin
This is the percentage of profit produced from total revenue. It is the measure of the profit a company makes per dollar of revenue and is calculated by dividing net income by revenue. Net income is the revenue left after all expenses and income streams have been subtracted. This includes COGS, one-time payments, secondary operations, operational expenses, investments, taxes, and debts.
Net Profit Margin equals net income divided by revenue times 100
Operating Profit Margin
This is also referred to as operating income margin, return on sales, and EBIT margin. It includes sales, overhead, administrative, and operating expenses required for the business. This involves all costs required to operate a business.
Operating Profit Margin equals operating income divided by revenue times 100
Why is Profit margin Important?
Profit margin variations offer helpful information to assess the growth potential of your business, as well as your financial stability compared to competitors and your overall viability. Of course, if there’s one that you should focus on, it’s your net profit margin. This indicates your overall profitability. If you can keep your profit margins healthy, you can ensure your financial success and improve your ability to qualify for a small business loan.
If you are in need of more information regarding your profit margin and help with keeping it where it needs to be, contact Crimson Stone Capital Solutions. We would love to help you ensure your business’s profitability.