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The profit margin reports how much money your business actually makes. During the course of your operations, you’ll spend money buying materials, assembling your products, and selling them to customers. Your profit is what remains from your sale after you subtract these costs.
The concept of a profit margin might seem straightforward, but it can be confusing—especially if this is your first time working with the formula. Check out these frequently asked questions to learn more.
On its most basic level, the gross profit margin is calculated with this formula:
For example, if you sell an item for $100 and materials and labor cost $75, then your gross profit is 25%.
The profit margin is typically represented as a percentage. However, you may notice gross profit on some financial documents represented as dollar amounts. This is the amount of income the business gets per item sold.
Gross margin is often used to calculate the profit from a single item or category of items. Net margin is used to calculate an entire organization’s profit margin. The formulas remain the same for both, but there are more expenses built into the net margin.
Yes. Business owners typically try to sell items with higher gross margin rates whenever possible. Often, businesses must choose whether to sell less of a good or service with a higher profit margin or more of a good or service with a lower margin.
For example, a baker might sell a cake for $20 that cost $5—profiting $15 (75%). The same baker might sell a cookie for $2 that costs $0.75 to make—profiting $1.25 (37.5%). The baker would have to sell 12 cookies to equal the same $15 profit from the single cake.
Every company has different costs and products that will affect their profit margins. However, a 15–20% net margin is considered “good.” New businesses tend to have lower profit margins closer to 10%.
There are several factors that affect your profit margin. If your rent is different from others in your industry, your margins will be higher or lower. Your employees, your vendor rates, and your products sold will also all affect your margins.
Yes. Your profit margin will change—sometimes frequently. For example, hiring an employee can hurt your profit margin in the short run as you onboard them and take on the extra payroll cost. Over time, a new hire should help your profit margin grow as they bring in more business and help you to scale your company.
Most companies look at their profit margins monthly to ensure that they’re operating with financial stability. However, you may want to check your margins after a big week or major sale just to make sure you were profitable.
Once you can calculate your profit margin formula, you can start making business decisions to grow your revenue and spend less money. To learn more, check out our guide on how to increase your profits by decreasing costs.
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