How to Calculate Profit Margin

Profit margin is one of the simplest and most widely used financial ratios in corporate finance. A company’s profit is calculated at three levels on its income statement, each with corresponding profit margins calculated by dividing the profit figure by revenue and multiplying by 100.

The most basic is gross profit, while the most comprehensive is net profit. Between these two lies operating profit.

Types of Profit Margins

There are three different types of profit margins: gross profit margins, operating profit margins, and net profit margins. Each one provides you with a peek at how efficiently a company is operating.

Gross Profit Margin

Gross profit is the simplest profitability metric because it defines profit as all income that remains after accounting for the cost of goods sold (COGS). COGS includes only those expenses directly associated with the production or manufacture of items for sale, including raw materials and the wages for labor required to make or assemble goods.

Excluded from this figure are, among other things, any expenses for debt, taxes, operating, or overhead costs, and one-time expenditures such as equipment purchases. The gross profit margin compares gross profit to total revenue, reflecting the percentage of each revenue dollar that is retained as profit after paying for the cost of production.

The formula for gross profit margin is:

$\begin{aligned}&\text{GPM}=\frac{\text{Net sales}-\text{COGS}}{\text{Net sales}}\times100\\&\textbf{where:}\\&\text{GPM}=\text{Gross profit margin}\end{aligned}$​GPM=Net salesNet sales−COGS​×100where:GPM=Gross profit margin​

Operating Profit Margin

Operating profit is a slightly more complex metric, which also accounts for all overhead, operating, administrative, and sales expenses necessary to run the business on a day-to-day basis. While this figure still excludes debts, taxes, and other nonoperational expenses, it does include the amortization and depreciation of assets.

By dividing operating profit by revenue, this mid-level profitability margin reflects the percentage of each dollar that remains after payment for all expenses necessary to keep the business running.

The formula for operating profit margin is:

$\begin{aligned}&\text{OPM}=\frac{\text{Operating Income}}{\text{Revenue}}\times100\\&\textbf{where}:\\&\text{OPM}=\text{Operating profit margin}\end{aligned}$​OPM=RevenueOperating Income​×100where:OPM=Operating profit margin​

Net Profit Margin

The net profit margin reflects a company’s overall ability to turn income into profit. The infamous bottom line, net income, reflects the total amount of revenue left over after all expenses and additional income streams are accounted for. This includes not only COGS and operational expenses, as referenced above, but also payments on debts, taxes, one-time expenses or payments, and any income from investments or secondary operations.

The formulas for net profit margin are either:

$\begin{aligned}&\text{NPM}=\left(\frac{\text{R}-\text{CGS}-\text{OPE}-\text{OTE}-\text{I}-\text{T}}{\text{R}}\right)\times100\\&\quad\qquad\qquad\qquad\qquad\qquad\textbf{\ or}\\&\quad\qquad\qquad\text{NPM}=\left(\frac{\text{Net income}}{\text{R}}\right)\times100\\&\textbf{where:}\\&\text{NPM}=\text{Net profit margin}\\&\text{R}=\text{Revenue}\\&\text{CGS}=\text{Cost of goods sold}\\&\text{OPE}=\text{Operating expenses}\\&\text{OTE}=\text{Other expenses}\\&\text{I}=\text{Interest}\\&\text{T}=\text{Taxes}\end{aligned}$​NPM=(RR−CGS−OPE−OTE−I−T​)×100 orNPM=(RNet income​)×100where:NPM=Net profit marginR=RevenueCGS=Cost of goods soldOPE=Operating expensesOTE=Other expensesI=InterestT=Taxes​

What Is a Good Profit Margin?

That depends on the company and the industry. That’s because profit margins vary from industry to industry, which means that companies in different sectors aren’t necessarily comparable. So, for example, a retail company’s profit margins shouldn’t be compared to those of an oil and gas company.

Having said that, you can use a scale of how a business is doing based on its profit margin. A profit margin of 20% indicates a company is profitable, while a margin of 10% is said to be average. It may indicate a problem if a company has a profit margin of 5% or under.

There are some studies that analyze profit margins by industry. New York University analyzed a variety of industries with net profit margins ranging anywhere from about -29% to as high as 33%. For instance, the study showed that the hotel/gaming sector had an average net profit margin of -28.56%, while banks in the money sector had an average net profit margin of 32.61%.

Regardless of where the company sits, it’s important for business owners to review their competition as well as their own annual profit margins to ensure they’re on solid ground.

How to Calculate Profit Margin in Excel

You may find it easier to calculate your gross profit margin using computer software. One of the most common ones on the market is Microsoft Excel. Using spreadsheets can make things a little easier. Before you sit down at the computer to calculate your profit, you’ll need some basic information, including revenue and the cost of goods sold.

In the first column (let’s say this is Column A), input your revenue figures. In the next one (Column B), note the COGS. In Column C, you’ll want to input the formula for your overall profit. So if you have figures in cells A2 and B2, the value for C2 is the difference between A2 and B2. Your profit margin will be found in Column D. You’ll have to input the formula, though: (C2/A2) × 100.

The table below is fairly simple but gives you an idea of how it works:

Example of Profit Margin

For the fiscal year ended Oct. 3, 2021, Starbucks (SBUX) recorded revenue of $29.06 billion. Gross profit and operating profit clock in at $20.32 billion and $4.87 billion, respectively. The net profit for the year is $4.2 billion. The profit margins for Starbucks would therefore be calculated as:

• Gross profit margin = ($20.32 billion ÷ $29.06 billion) × 100 = 69.92%
• Operating profit margin = ($4.87 billion ÷ $29.06 billion) × 100 = 16.76%
• Net profit margin = ($4.2 billion ÷ $29.06 billion) × 100 = 14.45%

This example illustrates the importance of having strong gross and operating profit margins. Weakness at these levels indicates that money is being lost on basic operations, leaving little revenue for debt repayments and taxes. The healthy gross and operating profit margins in the above example enabled Starbucks to maintain decent profits while still meeting all of its other financial obligations.

How to Improve Your Profit Margin

If you are a business owner, improving your profit margin is an important part of growing your company. Your profit margin shows how much money you make from every dollar of your gross revenue. When you improve your profit margin, you actually make more money without needing to increase sales or gross revenue.

Track Income and Expenses

Hopefully, you are already tracking your profits. But to improve your profit margins, you also need to know how much you are spending.

Every expense lowers your profit margin. Sometimes this is unavoidable; you will need to pay for supplies, website hosting, employee salaries, and many other expenses. But by tracking your expenses, you’ll be able to identify unnecessary expenses that can be trimmed to increase your profit margin.

Buy in Bulk

Does your business regularly buy and use the same supplies over and over? These could be for daily operations, to make goods, or even to ship products to customers. Whatever your regular supplies are, don’t just buy them when you need them. Pay attention to the price, and buy in bulk when prices are low or supplies are on sale.

When you buy in bulk, you pay less on average per item, which further decreases expenses and increases the profit made on each sale.

Increase Efficiency

Are there any parts of the business process that you can automate? No matter what type of business you run, taking more time costs more money.

Is there software you can use to collect and organize customer information? Can you use tracking software to manage shipping data and customer notifications? Automating some steps in the process or finding other ways to increase efficiency can save both time and money, allowing you to make more sales in the same amount of time and increase your profit margin per sale.

Prioritize Customer Retention

Finding new customers and marketing your goods or services to them consumes time and is expensive. But when you focus on ways to increase customer retention, you can continue to make sales to the same people over and over without the expense of lead generation and conversion.

Use automated emails—or personal ones!—to follow up with new customers. Offer discounts for repeat purchases. Show customers you value them through your social media communication or a rewards program. When your marketing expenses go down for each sale, the profit of that sale goes up, increasing your profit margin.

Know What Sells

You know which of your products customers like. If there is an item or a service that isn’t popular, continuing to invest time and money in creating, storing, promoting, and otherwise trying to sell it will increase the expense of each sale without making you more profit.

Many businesses regularly eliminate low-performing inventory or change their service offerings. If a product or service sells well, keep it around. But cutting low performers will lower your costs and increase your sales, which will raise your profit margin as well.

The Bottom Line

Profitability metrics are important for business owners because they highlight points of weakness in the operational model and enable year-to-year performance comparison. For investors, a company’s profitability has important implications for its future growth and investment potential. In addition, this type of financial analysis allows both management and investors to see how the company stacks up against the competition.

Profit margins are used to determine how well a company’s management is generating profits. It’s helpful to compare the profit margins over multiple periods and with companies within the same industry.