What is Profit Margin?
Profit margin is a measure of profitability expressed as a percentage. It shows how much of each dollar in revenue becomes profit. Higher margins indicate a more profitable business.
Types of Profit Margin
1. Gross Profit Margin
Gross Margin = ((Revenue - Cost of Goods Sold) ÷ Revenue) × 100
Measures profitability after direct production costs.
2. Net Profit Margin
Net Margin = (Net Income ÷ Revenue) × 100
Measures overall profitability after all expenses.
Calculating Profit Margin
Example:
You sell a product for $100, and it costs you $60 to make:
- Profit = $100 - $60 = $40
- Profit Margin = ($40 ÷ $100) × 100 = 40%
Markup vs Margin
These are NOT the same! Margin is based on selling price, markup is based on cost.
| Metric | Formula | Example |
|---|---|---|
| Margin | Profit ÷ Price × 100 | $40 ÷ $100 = 40% |
| Markup | Profit ÷ Cost × 100 | $40 ÷ $60 = 66.7% |
Margin to Markup Conversion
Markup = Margin ÷ (1 - Margin)
Margin = Markup ÷ (1 + Markup)
Margin = Markup ÷ (1 + Markup)
Industry Benchmarks
| Industry | Average Net Margin |
|---|---|
| Software | 20-25% |
| Financial Services | 15-25% |
| Healthcare | 10-15% |
| Retail | 2-5% |
| Restaurants | 3-9% |
| Grocery | 1-3% |
Improving Profit Margins
- Increase prices if market allows
- Reduce costs through better suppliers or efficiency
- Improve product mix - sell more high-margin items
- Reduce overhead - optimize operations
- Increase volume - leverage economies of scale
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