How to Calculate Profit Margin

As a small business owner in Canada, it is important to know the amount of profit your company is bringing in. You may want to know how to mark up certain products to bring in revenue, but profit margins can help give you a better idea of how profitable your products or services are through assessing your business’s financial health. 

By calculating the profit margin, you can measure the performance of your business and track financial information for the purpose of improving margins. However, before we can figure out how to calculate it, it’s crucial to first understand what profit margin is. 

What Is Profit Margin?

Briefly, the profit margin is how much money your business makes by dividing the company profit by its revenue. It is almost always conveyed as a percentage. By comparing sales to profit, you can get an idea of how well your business is doing financially. It can also help you observe the health of your business and resolve any financial issues quickly. 

Profit margin is often used by investors, creditors, and other companies to discover a business’s financial health, growth potential, and management skill. 

Determining Profit Margin

You can determine profit margin in several different ways. However, to calculate the profit margin of your business overall, you will use the net profit formula: 

Profit Margin = (Net Income / Revenue) x 100

Multiplying it by 100 simply turns the final figure into a percentage. If you do not know the net income of your business, you can easily calculate it by using this method: 

Profit Margin = [(Revenue – Cost of Goods Sold – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue] x 100

There are three varieties of profit margins that you can use to evaluate your small business: net, gross, and operating profit margin. 

Net Profit Margin

Net profit margin determines the profit that can be expected from the total number of sales after the income and expenses are paid. It shows how profitable your business is overall by calculating things such as operational expenses, taxes, one-time payments, debt payments, the cost of goods sold (COGS), and any investment income. 

The formula is as follows: 

Net Profit Margin = (Net Income / Revenue) X 100

Example

In this example, we will first calculate what your company’s net income is. You would use the formula: 

Net Profit Margin = [(Revenue – Cost of Goods Sold – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue] x 100

You would subtract the following example expenses from the revenue: 

• COGS: $1,000
• Operating expenses: $1,300
• Other expenses: $800
• Interest: $280
• Taxes: $600

If you have a revenue of $25,000, you would plug all of these numbers into the above formula to find the net profit margin. It would look like this: 

[($25,000 – $1,000 – $1,300 – $800 – $280 – $600) / $25,000)] x 100

The total net profit margin of your business would be 84% after multiplying it by 100. 

Gross Profit Margin

Gross profit margin determines how much profit you make for selling specific products. You calculate this profit margin by subtracting the cost of goods needed to make the product, or COGS, from the amount you sell it for, or the revenue. The formula is as follows: 

Gross Margin = [(Total Revenue – COGS) / Total Revenue] X 100

If your business provides a service instead of a product, you would use the total cost required to achieve a sale rather than COGS. 

Example

To determine gross profit margin for specific products, you must know two things: the revenue of each item, or how much it sells for, and the COGS, or the cost to make it. 

If you’re selling a sweater for $30 and it costs $10 dollars to produce, the formula would look like this: 

Gross Margin = [($30 – $10)] / $30] x 100

The gross profit margin would be 66%, meaning you make 66% on every sweater sold. 

Operating Profit Margin

The operating profit margin includes the total business expenses required for daily business operations. It does not take into account non-operational expenses, such as taxes and debt. You would use this type of profit margin to calculate the earnings you make from operating activities before interest and taxes. 

The formula for the operating profit margin is below: 

Operating Profit Margin = (Operating Income / Revenue) X 100

Example

To find out your company’s operating profit margin, you simply need to know what your operating income and revenue are. 

For example, if $8,000 is the operating income and $30,000 is the revenue, the formula would feature the information as follows: 

Operating Profit Margin = ($8,000 / $30,000) x 100

The operating profit margin for your business would be 26.67%. 

Standard Profit Margins in Various Industries

Depending on which industry you are in, the profit margins can vary. Several factors affect it, such as the operating systems you use, the total employees, and your business type, size, and location. 

If you wonder whether or not your small business is meeting the standard profit margins, here are examples of different industries’ average net profit margins: 

How to Improve Your Profit Margin

After calculating the profit margin for your business, you may want to raise it. To do so, some small adjustments will be required. Overall, you desire to increase sales and lower your expenses and costs. 

Some ways you can consider to raise sales may be: 

• Increase prices accordingly
• Have sales on unsold inventory
• Use cross-selling and upselling techniques
• Retain customers
• Make products more visible

Consider doing the following to decrease costs: 

• Reduce operating and business expenses
• Optimize relationships with vendors
• Cut products that do not sell
• Eliminate any waste
• Search for alternative solutions to increase efficiency and lower costs

Calculating a Markup

Markups also examine the profit of various products but from a different perspective. It can help you see the relationship between the cost of goods sold and profit. It shows how much you can make if you price certain items higher than their cost. It is most often calculated per product. 

To use the markup formula, you will need to first calculate the gross profit for the item or service you want to analyze. Then you need to add up the cost of materials, labour, and other goods or services necessary to make the item. 

Here is the formula for determining markup: 

Markup = Gross Profit / COGS

Standard markups are also expressed as a percentage, and there is a vast difference in markups depending on the industry. While grocery store products like milk and bread may have a markup of around 5-8%, coffee shops normally have markups of around 300%.

Conclusion

Knowing how to calculate profit margins can help you assess the financial health of your small business. Margins show the relationship between your revenues and profits, and you can make changes to your business strategies accordingly. 

Net profit margins help you see the bigger picture, while gross profit margins examine each product or service you sell. Operating profit margins allow you to see how profitable it is to run your store every day.