Use this calculator to help determine the ideal selling price for a product to achieve your desired profit margin on sales. Start by entering your wholesale product cost, and then enter in your gross margin percentage or markup to find the selling price. If your business has a mix of products for sale you can enter up to 10 different products in your inventory mix. When you are done with your calculation click on the "View Report" button to view a printable version of the results. This calculator shows the gross profit on items but does not account for other fixed business costs that act as inputs into the net margin on sales.
Do you prefer to conduct your calculations offline? If so, we offer a number of helpful Excel spreadsheets to help businesses stay organized & on top of their finances & financial projections.
Companies need to generate profits to keep their businesses afloat. But how do businesses know if they’re earning enough money? This is where profit margin comes in. Monitoring profit margin gives a picture of your company’s financial health. It can tell you if your business has further potential for growth.
Whether you’re running a small startup or a large corporation, it’s imperative to track your earnings. Our article will discuss profit margin, factors that determine it, and how it’s calculated. We’ll include the different types of profit margin and how businesses can use them to gauge their financial standing. Finally, we’ll talk about different strategies businesses employ to improve their profit margins and increase their market share.
Profit margin is a ratio that measures how much a company or business activity generates money. It’s the extent of your company’s earnings relative to its revenue. This metric is regarded as one of the most important indicators of business efficiency. Expressed in percentage, profit margin indicates how much of a business’s sales has turned into profits. In particular, the percentage reflects how many cents of profit the company earned for each dollar of sale.
Companies calculate profit margin at a designated frequency. Small businesses such as local shops can compute profit margins on a weekly, bi-weekly, or monthly basis. Meanwhile, larger companies typically compute profit margin on a standard period, such as a quarterly or annual basis. For example, a software company reached 20% profit margin in one year. That means it generated a net income of $0.20 for every dollar of sale.
Why is Profit Margin Important?
Tracking profit margin is crucial not just because it shows how much money a business makes. It reveals the general financial condition of a business. It also shows if there are pricing and cost problems that need to be addressed. When your profit margin is low, you might not be achieving the best return on investment (ROI) for the expenses of the business.
In determining profit margin, you essentially monitor how much revenue is flowing to your company’s bottom line. Reviewing profit margins will help identify pricing problems which need adjustment. If your pricing errors are not addressed, it can cause major cash flow issues. This can hinder you company’s growth, and at worse, drive your business to insolvency.
There are different types of profit margins reflected on a business’s income statement. Companies can calculate four main types of profit margins, which are as follows:
Out of the four, net profit margin is considered the most significant. That’s because it accounts for your company’s entire revenue after all the costs. By calculating the net profit margin, a company can also account for its gross margin, operating margin, and pretax margin.
When a business earns sales revenue, it pays for costs to develop a product or service. After accounting for these costs, what’s left is the gross profit margin. The company also pays for other costs associated with running the business. This includes overhead expenses such as maintaining an office. It also includes marketing, advertising, as well as research and development. When we account for these costs, what’s left is the operating profit margin.
Next, businesses pay for interest on their debt. Since many companies obtain commercial loans to finance their business, this adds to the company’s costs. It also includes any irregular charges and inflows the business has incurred. This leaves the company with what’s called the pre-tax profit margin. Then, what money is left after paying business taxes is the net profit margin, also called the net income. The net profit margin represents the bottom line of the company’s profits.
The following sections will discuss how each type of profit margin is calculated.
Gross profit margin (GPM) is the income left over after a business pays for direct expenses. Direct expenses refer to the cost of creating or developing a product or service. It includes the cost of raw materials, direct labor, and manufacturing expenses needed to produce and deliver goods or services. This is often referred to as ‘costs of goods sold’ (COGS).
Expenses such as interest, taxes, and operating costs are not computed in the gross profit margin. To determine this percentage, businesses use the formula below:
Gross Profit Margin = [(Total Revenue – COGS) / Total Revenue] x 100
Let’s use simple figures to illustrate how this calculation works. Suppose a company sells a product for $100. If it costs $50 to make that item, they can make a gross profit of $50 with each product sold. This leaves them with a 50% gross profit margin.
= [(100 – 50) / 100] x 100
= [50 / 100] x 100
= 0.5 x 100
Cost of goods sold (COGS) may also be called ‘cost of products sold’ or ‘cost of sales’ in an income statement. Determining the gross profit margin is beneficial for companies when they need to assess their product suite. The computation is done per product, which gives businesses a good idea how much they spend producing goods or services. It also gives them insight into how they can further streamline the cost of production. If they can reduce production costs, it helps increase gross profit margins.
The operating profit margin (OPF) is determined by subtracting various operating expenses from the business’s gross profit margin. It’s basically the earnings a company makes after accounting for operational expenses, such as the cost of maintaining an office. It also includes expenses such as research and development, as well as marketing and advertising the company’s products. The OPF is a direct reflection of how well a business is allocating its resources.
The operating margin is also referred to as ‘earnings before interest and taxes’ or EBIT margin. Your company’s income statement may also list it as ‘operating income margin,’ or ‘return on sales.’ It’s calculated using the following formula:
Operating Profit Margin = [(Gross Profit – Operating Expenses) / 100] x 100
For example, a company earns $100 when it sells a product. It spends $50 to create the product and $20 in operating costs. If we compute the revenue, the cost of making the product, and the operating cost, the resulting operating profit margin will be 30%.
= [(100 – 50 – 20) / 100] x 100
= [30 / 100] x 100
= 0.30 x 100
Companies calculate their total profits before paying taxes. After computing for the operating profit margin, they must subtract other expenses such as interest payments from debt. Many businesses obtain commercial loans to finance their company, which offered them capital to run and develop their operations. Besides interest expenses, the calculation may also account for non-recurring factors, such as gains or losses from discontinued operations. To determine the pre-tax profit margin, you can use the standard formula below:
Pre-tax Profit Margin = (Earnings Before Taxes / Revenues) x 100
For example, suppose a company pays $10 interest payments for every product sale at $100. The operating cost is $20, and the cost of making the product is $50. If we compute for the pretax profit margin, it will be 20%.
= (100 – 50 – 20 – 10) / 100) x 100
= (20 / 100) x 100
= 0.2 x 100
The most common computation used by companies is the net profit margin (NPM). This factors in everything from the cost of making the products or services, operating expenses, all the way to interest payments on debt and taxes. Net profit margin determines a company’s net income, which is what’s left after accounting for all the costs. This is the bottom line which can reveal the worst case scenario for a business if it fails to gain profits. The net profit margin formula is written below:
Net Profit Margin = (Net Profit / Total Revenue) x 100
For example, let’s suppose the cost of a product is $100. The cost to make that product is $50, while the operating expense is $20. The interest cost is $5, while the tax expense is $10. In this example, the net profit will be $15 and the net profit margin will be 15%
= (15 / 100) x 100
= 0.15 x 100
If our example were written in an income statement, it would look something like this:
|Cost of goods sold (COGS)||$50|
Net profit margin is considered a better marker of financial health than revenues alone. It can happen that a company’s earnings increases while the profit margin drops. This means that a business is turning relatively less efficient. It cannot gain a net profit margin if the business is losing money.
Identifiable factors that impact profit margin are the cost of goods or services and sales volume. You’ll notice how sales prices are very important for increasing profit margin. When done properly, raising prices can be more efficient than relying on selling more products. Likewise, increasing product sales will help raise a company’s profit margin.
As your business grows, costs do not remain the same. You eventually need to increase prices as your expenses rise. However, to justify price increases, keep in mind that companies must maintain a level of quality for their product or service. If you manage inventory costs well and increase your profit margin, you can increase your product’s sales price at the same time.
Besides the cost of goods and sales earnings, the type of business has a greater influence on profit margin. Note that a company’s profit margin is determined largely by three factors:
Profit margins vary greatly between different sectors of the economy. Certain types of companies tend to have higher profit margins than others. Thus, when investors analyze average profit margins, they compare it with companies in the same industry.
For instance, industries that typically have high net profit margins are accounting and tax preparation firms, legal services, and real estate industries. These tend to have lower expenses compared to other businesses. Meanwhile, restaurants, food service, and recreational industries typically have lower profit margins. These businesses usually deal with greater expenses than other businesses.
It would not make sense to pit a company with another that does not operate within the same business. And even in the same industry, when investors compare profit margins, they also consider the size of the company and if it has the same business model. Gauging profit margin by industry is a crucial factor to consider when you’re setting goals for your company.
For example, a large company that sells luxury clothing may be less inclined to offer large discounts for its products. On the other hand, a mass brand clothing company appeals to a larger segment of consumers. Unlike the luxury brand, a mass brand company may use heavy discounts as a strategy to drive more sales. While they both sell clothes, each company has a different business model. Though you may compare their profit margins, it makes better sense to compare a luxury clothing company with another high-end clothing brand instead. It gives you a better idea if that business if performing well among its competitors.
In January 2021, NYU Stern School of Business published profit margins by sector in the U.S. The following table shows the average net profit margin and gross profit margins across different U.S. industries.
|Type of Industry||Number of firms||Gross Profit Margin||Net Profit Margin|
|Auto & Truck||19||9.04%||1.40%|
|Bank (Money Center)||7||100.00%||20.98%|
|Brokerage & Investment Banking||39||60.83%||12.71%|
|Business & Consumer Services||169||36.81%||2.47%|
|Coal & Related Energy||29||19.73%||-31.79%|
|Electronics (Consumer & Office)||22||35.69%||-1.53%|
|Environmental & Waste Services||86||33.29%||3.52%|
(Non-bank & Insurance)
|Green & Renewable Energy||25||58.83%||-34.82%|
|Healthcare Support Services||129||15.51%||2.63%|
|Investments & Asset Management||348||69.23%||19.51%|
|Metals & Mining||86||24.02%||1.64%|
|Office Equipment & Services||22||35.26%||1.95%|
|Oil/Gas (Production and Exploration)||278||50.97%||-78.85%|
|Packaging & Container||26||22.39%||2.98%|
|Publishing & Newspapers||29||40.81%||-6.27%|
|Real Estate (Development)||25||23.68%||-0.32%|
|Real Estate (General/Diversified)||11||49.31%||5.12%|
|Real Estate (Operations & Services)||61||32.88%||1.53%|
|Retail (Building Supply)||15||34.48%||7.53%|
|Retail (Grocery and Food)||14||26.25%||2.20%|
|Retail (Special Lines)||85||28.16%||-0.10%|
|Shipbuilding & Marine||11||23.66%||-5.99%|
|Software (System & Application)||388||72.19%||19.99%|
What is a Good Profit Margin?
A good profit margin depends on a confluence of factors. Aside from the industry, things like whether you’re new in the business, if you’re a small company, and if you have a large client base impacts your profit margin. The best way to determine your ideal profit margin is to look at the average profit margin in your industry. For instance, restaurants typically aim for a profit margin between 6% to 9%. Meanwhile, those in the construction industry try to maintain around 5%.
While profit margins vary considerably per industry, the Corporate Finance Institute states that investors can still set levels for net profit margins. Generally, a 5% net profit margin is considered low, a 10% net profit margin is considered average, a 20% net profit margin is deemed good or high. But again, a company’s profit margin is largely affected by the type of industry, its size, and other industry-specific factors that affect sales.
Company size is an important factor to consider when gauging profit margin. Small companies generally have lower profit margins compared to established corporations. Some business owners may choose to remain small and aim to maintain a regular profit margin. If you own a local shop, you may have this kind of mindset. However, consider striving for a higher profit margin to keep your business running. Though small businesses usually have lower profit margins, they also tend to have less employees and lower expenses. Thus, they can turn a larger portion of their revenue into profits.
In the future, you might need to have your shop renovated for timely improvements. Earning a higher profit margin will help you secure the funds necessary for renovations. This will keep your current customers while drawing new patrons in your establishment. In other cases, you may need to have emergency repairs done, which can throw your finances off track. By increasing your profit margin, it can help you cover future expenses, keeping your business afloat.
Companies that plan to expand must increase their profits and cash flow at a steady pace. They usually outline clear business plans and have a timeline for goals to achieve stable expansion. Without boosting profit margins, a company will not have the resources to further develop and grow. Earning more revenue will allow you to offer more products and services to your customers. You’ll have enough money to make product and service improvements to increase your business.
If you sell products, you can also boost production as more demand pours in. And if you see an opportunity to market in other lucrative locations, depending on your industry, you can expand to other territories as you see fit. Large businesses that have ample capital can merge with or acquire another company, which is another strategy to grow sales and revenue. It’s also an effective way to increase your company’s market share.
Profit margins are also a primary reason why many businesses outsource jobs overseas. This is because U.S. workers tend to cost companies more than workers in other countries. They do so to sell products at competitive prices while maintaining their target margins. To maintain low product or service price, many U.S. companies outsource jobs to lower-cost workers located in India, China, Malaysia, and other countries.
A company’s profit margin isn’t just a metric that should regularly be tracked. It’s a financial indicator that businesses should strive to improve. If your profit margins drop or remain stagnant for years, chances are your company isn’t thriving. That said, there are general ways to improve profit margin even across industries.
Here are several strategies you can take to increase your company’s profit margin.
Raising prices might be the most apparent way to increase a business’s profit margin. While it’s important to adjust pricing correctly, note that raising prices entails plenty of considerations. You have to do more detailed research about your market and competitors before making price changes. It’s also important to consider by how much you’ll raise the product or service price. Before anything else, be sure to conduct surveys and focus group research before adjusting its current value.
Here are important factors you should consider before adjusting prices:
How much is your product or service now compared to your competitors? Note that it can be risky to raise your price if your competitors have the same price or less. If your product/service has similar features, you’ll have to justify the price increase. Your product should have a unique selling point and higher quality perception if you are to persuade consumers to continue purchasing what you offer.
Can you easily add extra features to your product at a low cost? Consider improving your product to justify the price increase. It should be a good feature that your customers would be willing to pay for if you provide it. Of course, this is easier said than done. You must find ways to offer this extra feature without incurring large costs. Also, consider if you can add the extra feature while maintaining competitive pricing. Offering a higher quality product at the same price as your competitors gives consumers a better reason to choose your product.
How much are you planning to charge? With this in mind, consider the number of customers you might lose with the price increase. If you supply certain products to regular customers, they may no longer be able to afford the product. Anticipate this scenario. Consider whether losing old customers might offset any extra earnings you obtain from raising prices.
Evaluate how much it costs to produce your product or service. It’s equally important to assess how much you’re spending to run your business operations. This is where calculating the gross profit margin and operating profit margin comes in handy. Watch out for unnecessary production costs you can get rid of. Perhaps certain equipment doesn’t need maintenance as often. If you need regular maintenance, negotiate the contractor rates. Make an effort to streamline your operations to reduce your business costs.
The following are steps you can take to reduce company expenses:
Talk to your supplier. Ask whether there’s a way to lower the cost of raw materials. Negotiate new rates with your supplier especially if you’ve been working with them for years. If your original supplier does not lower their rate, consider looking for other suppliers. You might obtain a better deal if you find a new one.
Negotiate with your landlord. If you’re renting an office or warehouse, talk to your landlord about your business concerns. Some landlords consider reducing rent if it means they can keep you renting for the long-term. That’s better than losing you and looking indefinitely for a new tenant. If not, look for more affordable locations where you can move your business.
Evaluate the labor costs. Paying for labor takes a considerable portion of your revenue. Check whether your business is authorizing too much overtime hours. In other cases, perhaps the turnover rate in your company is too fast. Training new employees that don’t stay long can be draining on your resources. Think about cross-training employees and promoting them to positions where they can manage different tasks. Moreover, invest in hiring high-quality employees that can help your business thrive.
If you’ve been in business for several of years, you’ve likely established regular clients who purchase your products or services. When you evaluate your client list, perhaps you have a client that demands too much and takes up most of your time. These clients may also pressure you to give them frequent discounts even if that wasn’t part of the deal. If this is the case, you might want to reconsider doing business with them.
Having difficult clients can cost you a lot of time and revenue, which puts strain on your business. Do they order a lot or frequently enough to justify keeping them? Consider these questions carefully. While we want to avoid cutting ties, staying with an unprofitable client may be detrimental for your business. If you want to keep this type of client, it’s time to push back and not bend to unfair demands. Moreover, think of how much extra revenue you can make if you spent time looking for new clients who are easier to deal with.
Depending on your business, if you sell different products, assess how you’re managing your inventory. Perhaps your goods are not stored and organized properly. Do you know when a product is being sold? Maybe you’re already low on a particular stock. Having a structured and efficient inventory system will help you stay on top of your sales. It also helps prevent theft that can seriously harm your profits.
Without a proper inventory management system, you cannot monitor your goods through the entire manufacturing process. Small businesses with single entry accounting systems usually have this problem, because their inventory is not tracked. You should know the product’s status from production, all the way to storage, shipping, and retail. An efficient inventory will also track returns and prompt if items go missing. Since there are products that have higher demand in certain seasons, you can use your inventory system to assess sales patterns. With these benefits in mind, make sure to prioritize efficient inventory management for your business.
Improve your brand’s reputation together with the quality of your products and services. Companies that are perceived to have better value often have good profit margins. For instance, in the retail industry, competitive beauty and cosmetics brands tend to excel at building personal and emotional connections with consumers. With certain types of products, companies can leverage on creating wholesome personal connections with customers compared to other consumer goods. They make effective advertising and marketing campaigns that drive sales.
Even across different industries, building a good reputation and client relationships is vital in increasing profit margin. This is why many companies invest in public relations, marketing, and advertising. It helps them better appeal to the market. Elevating your company’s reputation, while increasing customer satisfaction, is an excellent way to strengthen customer relationships. Improving customer service goes a long way in attracting and keeping existing clients. It’s a key factor in increasing your company’s market share. Likewise, a greater market share will raise your business’s profit margin.
According to Corporate Finance Institute, there are different factors that can increase your market share:
Profit margin is a financial ratio that measures how much money a business earns relative to its total revenue. Investors, creditors, and businesses themselves measure profit margin to gauge a company’s financial health. It’s a good indicator for assessing a company’s management skills and potential for growth.
You can compute four types of profit margins: gross profit margin, operating profit margin, pre-tax profit margin, and the net profit margin. The calculation divides the company’s income by revenues until you reach the bottom line. This reveals your net profit margin, which indicates how much income your business generated after accounting for all costs.
Profit margins are determined by the type of industry, the size of the business, and whether the company has plans to expand. The price of goods and sales volume also greatly impact a company’s profit margin. Since profit margins vary widely across industries, it’s best to compare net profits with similar companies.
Certain types of industries tend to have higher profit margins than others. These include accounting firms, legal services and real estate industries. Businesses like these don’t entail a lot of costs. In contrast, restaurant and food industries typically have lower margins because they deal with a lot of costs.
Companies can improve their profit margin by using several strategies. This includes adjusting prices to optimize sales and cutting down on unnecessary expenses. You can do this by negotiating prices with your supplier, or even looking for a cheaper office to reduce rental expenses. Another strategy is to improve your inventory management. With an efficient management system, you can better track when your goods are being distributed. Finally, elevating your brand and increasing quality improves your company’s reputation. In the long-run, this can raise your market share, which drives further growth.