How to Calculate Profit Margin
Tomas ?vinklys - Kreg?d?
Profesional in General Management, Commercial Management, Operations, Logistics, Food and Beverage, Finance, Human resources...
Profit margins are 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. This most basic is gross profit, while the most comprehensive is net profit. Between these two lies operating profit. All three have corresponding profit margins calculated by dividing the profit figure by revenue and multiplying by 100.
KEY TAKEAWAYS
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:
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:
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:
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 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.
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) x 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.2 The profit margins for Starbucks would therefore be calculated as:
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.
领英推荐
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.
IMPORTANT: Never increase efficiency at the expense of your customers, employees, or product quality. While this may initially increase your profit margins, the long-term effects will negatively impact your customers' experiences, which can cause higher rates of returns, decreased sales, poor employee performance, and other problems that can lower your business's credibility and decrease your profit margin.
Prioritize Customer Retention
Finding new customers and marketing your goods or services to them is time-consuming and 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.
What Is a Good Net Profit Margin?
A good net profit margin varies widely among industries. Margins for the utility industry will vary from those of companies in another industry. According to a New York University analysis of industries in January 2022, the average profit margins range from nearly 29% for railroad transportation to almost -20% for renewable and green energy. The average net profit margin for general retail sits at 2.65%, while the average margin for restaurants is 12.63%.1
So, a good net profit margin to aim for as a business owner or manager is highly dependent on your specific industry. It’s important to keep an eye on your competitors and compare your net profit margins accordingly. Additionally, it’s important to review your own business’s year-to-year profit margins to ensure that you are on solid financial footing.
Which Profit Margin Formula Is the Most Useful?
The most significant profit margin is likely the net profit margin, simply because it uses net income. The company’s bottom line is important for investors, creditors, and business decision-makers alike. This is the figure that is most likely to be reported in a company’s financial statements.
However, each formula has its own value for internal analysis. The gross profit margin can be used by management on a per-unit or per-product basis to identify successful vs. unsuccessful product lines. The operating profit margin is useful to identify the percentage of funds left over to pay the Internal Revenue Service and the company’s debt and equity holders.
Are There Other Profit Margin Formulas?
Yes. An adjusted gross margin is also useful for internal analysis. It is similar to gross profit margin, but it includes the carrying cost of inventory. Two companies with similar gross profit margins could have drastically different adjusted gross margins depending on the expenses that they incur to transport, insure, and store inventory.
Profit margin can also be calculated on an after-tax basis, but before any debt payments are made. This is referred to as an after-tax unadjusted margin. It more directly identifies the funds left over to pay lenders.
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.
Experienced Start-up Co-Founder and CEO.
5 个月Hi Aivaras, this is a great post, thanks for sharing. I’ve personally being researching this a bit myself for my own business and found that there are several ways to do this and it’s not entirely set in stone. For example, for gross profit, some e-commerce businesses include cost of sale (e.g. fulfilment fees)within in the COGS line item. Obviously including all costs associated with a consumer sale would return wildly different gross margins than not including them so it’s an important point. Also, I’ve seen businesses switch the net profit and operating profit around compared to how you explained it in your article. For example, in my business we operate two brands. We calculate net profit for each brand vertical, and operating profit on the umbrella company. What are you views on this?