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Knowing your company’s profits and profit margins is critical for success. The goal of all businesses is for its bottom line to show a profit so it can continue to grow and increase profits for the next year. Here is a simple guide on how to calculate your business profit margin.
A profit margin is the percentage of sales revenue which the company keeps after deducting the costs to run the business. These costs fall into two categories – the cost of goods sold and operating expenses. However, there are more than two types of profit margins to consider.
Generally, there are three types of profit margins: gross, operating and net. Each one can be calculated by dividing the profit (revenue minus costs) by the revenue, then multiplying that figure by 100 to get your profit margin percentage. Let’s look at each type of profit and the costs that figure into its calculation.
Gross profit margin shows your profit percentage over your production costs. In other words, your gross profit represents the total revenue from your sales minus the cost of goods sold. Your cost of goods sold include all your costs to produce the product, including materials, labor and more.
Using the gross profit formula, let’s say you made $500,000 in total revenue from selling 10,000 products. However, it costs you $200,000 to produce those products. In this case, the gross profit calculation would be $500,000 – 200,000 = $300,000.
Divide that figure by total revenue to get your gross profit percentage: $300,000/$500,000 = 0.60 or 60%. Therefore, your gross profit margin would be 60 percent.
Your operating profit is your total revenue after your cost of goods sold and all your other expenses, relating to the operational and administrative aspects of running your business, including employee salaries, rent, and more.
To calculate your operating profit using the gross profit figure above, let’s say your total operating expenses are $100,000. The formula to use would be $300,000 - $100,000 = $200,000 in operation profit, which is also considered your pre-tax profit. Divide that figure by total revenue ($200,000/$500,000), and you get 0.40 or a 40% operating profit margin.
The overall profitability of a business is indicated by its net profit, which factors in even more deductions from revenue. Net profit equals total revenue minus cost of goods sold, operating expenses, as well as taxes and interests.
Using the previous scenario with total revenue of $500,000, after subtracting cost of goods sold ($200,000) and operating expenses ($100,000), you’re left with $200,000, which was your operating profit. If you paid $50,000 in taxes and interest and subtract that amount, you're left with $150,000, which is your net profit. The net profit margin would be $150,000/$500,000 which equals 0.30 or 30%.
To make these calculations easier to digest, below is a simple breakdown of each profit margin formula:
You may be wondering what a preferable profit margin would be. Favorable profit margins vary considerably by industry, but generally, a 10% net profit margin is considered average, a 20% margin is deemed to be high (or good), and a 5% margin is low. But these guidelines vary by types of business and are impacted by several other factors.
While profit margins alone cannot give a complete picture of your company's financial health, it can certainly help identify where adjustments can be made to increase your bottom line – such as raising prices, cutting down on certain expenses, and more. This is where Everlance can help.
Everlance is the #1 app for helping businesses and their employees keep track of all their expenses, including car mileage for tax or reimbursement purposes. Everlance silently records drives and expense in the background and can be categorized as business or personal by swiping right for business trips, then the app intelligently created IRS compliant records for you and your accountant or business finance departments.
Everlance allows all expenses to be recorded and monitored by simply taking photos of receipts. You can even link your credit card or bank account to track business expenses that way too. Whether you are self-employed or run a company with several employees and need a mileage reimbursement program, you can download these reports to analyze expenses and revenue at any time, while staying on top of profitability. If changes need to be made to increase your profit margins, you can make those modifications sooner rather than later, thanks to the ease and accessibility and that Everlance offers when it comes to business expense tracking.
We help people save time and money. At Everlance, we're on a mission to empower mobile workers and businesses. That sometimes leads us to generalize tax information. Everlance team members are not certified tax professionals. If you need help with your specific tax situation, please reach out to your tax advisor.
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