How to Determine Your Profit Margin

Your profit margin is a key piece of information about the health of your business. You’ll need it to create a good business plan, monitor your costs, adjust your prices, and as a measurement of how profitable your business is over time. Your profit margin is expresses as a percentage; the higher the percentage, the more profitable your business is. The methods below will help you calculate your gross profit margin, either as an established business or as one just starting out.

EditSteps

EditCalculating Profit Margin

Calculate the total revenue generated by your business. Revenue is the total amount of gross sales. This figure is all of the products you sold, multiplied by the price of the products.
- Usually, businesses measure revenue by quarter or by year. It doesn't matter which you choose. As long as your sample size is big enough, revenue will be roughly the same from quarter to quarter, although it can be substantially different from quarter to year.

Subtract any and all expenses from your revenue. Overhead costs, production costs, taxes, and interest payments — whatever expenses the company had to pay for should be subtracted from whatever the company made.
- For example, if your business earned $100,000 and spent $70,000 on goods, taxes, and interest combined, you subtract $70,000 from $100,000, leaving you with $30,000.

Divide the difference by the total revenue. Because profit margin is a percentage, you'll want to divide the difference by whatever revenue you started with in the first place, and then multiply by 100.
- In our example above, our difference was $30,000. $30,000 ÷ $100,000 = .3
- Multiply this result by 100 to turn it into a percentage. .3 x 100 = 30%

EditMaking Sense of Profit Margin

Know what profit margin tells you. Profit margin is often listed as a percentage, but it's basically a calculation of how many cents you take home, or profit, for every dollar. So, if your profit margin is 30%, that means that you take home 30 cents for every dollar that you earn. If your profit margin is 50%, you take home 50 cents for every dollar you earn.

Learn to compare two companies by looking at their respective profit margins. If you're looking at investing in a stock, for example, you can compare the prospective stock's profit margin against those of its competitors.
- Say that Company 1 has revenue of $500,000 and total expenses of $230,000. This would give it a profit margin of 54%.
- Assume that Company 2 has revenue of $1,000,000 and total expenses of $580,000. This means that Company 2's profit margin is 42%.
- Company 1 has a better profit margin, even though Company 2 makes double of what Company 1 does and has a higher net profit. If you were going to invest in Company 1 or Company 2, you may want to consider investing in Company 1, despite what its numbers look like on the surface.

Compare apples with apples when comparing profit margins. Although you're perfectly capable of doing it, comparing two or more companies in different sectors and of different scales won't give you an accurate picture of which company you should invest it. It's best to compare two or more companies in the same industry and with similar revenues in order to make the most of the comparison.

Perform a simple estimation if identifying profit margins of a new business. If you are just starting your business and don’t have a history of income reports to work with you can still estimate your potential gross profit margin with a little work. Look at your competition and try to find out what their gross profit margins are. You can look at their product pricing and use your understanding of costs to get a rough idea of what your profit margin might be.
- Use the calculations from section one above once you’ve identified the potential costs and revenue of similar businesses. For example, if you estimate your competition’s revenue as $200,000, and their costs as $125,000, the profit margin for your new business would be about 37%.

Don't confuse profit margins with markup. Markup is the difference between what something costs to produce and how much it is sold for. People sometimes erroneously confuse the two or believe they are identical.

EditTips

There are a number of online calculators that can help you assess your gross profit margin.

You can increase your business’s gross profit margin by increasing the number of sales, lowering costs with cheaper materials or less labor, and raising prices.

Use this calculation to estimate the profitability of a single product you suspect may be earning less than other products. If you have a small profit margin for a particular product, consider how to reduce the cost of that product or whether it’s worth continuing to sell the product at all.

Compare the results of your gross profit margin at different times to determine whether your business is becoming more profitable. For example, compare the results from one year to the next.