Business owners can calculate profit margin by comparing their company’s profits to its total revenue for a specific time period. Before we dive into profit margin, let’s define a handful of financial metrics that impact the calculation.
Profit is the amount of money or earnings a company has after paying for business expenses. There are several different types of profit calculations, including:
- Gross profit, which is income that remains after subtracting the cost of goods sold (COGS);
- Operating profit, which is the remaining income after accounting for both the cost of goods sold (COGS) and daily operating or administrative expenses; and,
- Net profit, which is the earnings left over after removing ALL expenses – the cost of goods sold (COGS), daily operating expenses, and any other expenses (like interest, taxes, and stock payments).
Profit margin gives businesses a financial gauge for how their profits compare to total revenue. By taking the gross, operating, or net profit and dividing it by total revenue, business owners can quickly see how they are performing financially.
Here’s a quick sample calculation:
For FY 2018, big-box retailer Best Buy had revenues of $42.88 million. Best Buy’s gross profit for the same period was $9.96 million.
($9.96 million / $42.88 million) X 100 = 23% gross profit margin
All of these calculations come from a company’s income statement. Business owners can calculate profit margin as they fill in the blanks of revenue and various types of expenses on the income statement.
What’s the Difference Between Profit, Profit Margin, and Markup?
The differences between these three financial metrics are subtle—but very important. Confusing them can give an improper view of how the business is performing.
Profit (as mentioned above) is the difference between all of a business’s income and its expenses for a set time period. That means profit (gross, operating, or net) will always be a dollar value—not a percentage.
Profit margin is the calculation that compares a company’s profits to its total revenue (also for a set time period). Because the calculation involves dividing one number by another, profit margin will always be a percentage—not a dollar value.
Markup, which may seem similar to margin, is the metric that shows how much more your product costs than what you are selling it for.
Let’s say you are selling chairs. Each chair costs you $125—that means all the materials, labor, etc. that goes into making each one. You charge $200 for each chair you sell.
To determine the markup, subtract what each chair costs you to make (COGS) from what you charge when you sell it.
$200 – $125 = $75
$75 is your gross profit per chair. Now take your gross profit per chair and divide it by the cost of making the chair.
$75 / $125 = .60
This is your markup. To convert it to a whole number, multiply by 100.
.60 X 100 = 60% markup
The markup on your chairs is 60%, meaning you sell them for 60% more than you pay to make them.
Markup and profit margin are similar in that they are both financial measures of profit. However, profit margin is an across-the-board measure, while markup applies specifically to product production.