How to Calculate Profit Margin(Net and Gross) for Your Business
There are two major things you need to stay viable in business, especially if you are in it for the long haul:
- Steady inflow of cash
- A healthy profit margin
While a steady inflow of cash ensures you have funds to keep your business running, a healthy profit margin gives you a reason to stay put.
To calculate your profit margin, simply divide your average profit by your selling price and multiply it by 100.
That is:
Profit margin = Profit (Selling Price – Cost Price)/Selling Price X 100.
We encourage you to read to the end to get a better idea of what margin is all about and how it differs from markup.
Key Takeaways:
- Margin isn't the same as markup. While the former is based on selling price, the latter is cost price.
- There are two types of margins: Gross and net margins.
What is Margin?
In the simplest terms, margin is the extra money that is left when you deduct the total unit cost of an item from how much it is sold for.
To put it in another perspective, margin is the extra money a business makes after deducting its total cost, relative to its revenue. It is expressed in percentage.
A positive margin means your business is profitable, while a negative one implies the opposite.
What is the Profit Margin Formula?
The formula for calculating profit margin is as follows:
Margin = (Selling Price – Cost Price)/Selling Price X 100
Another way to put it is:
Margin = (Revenue – COGS)/Revenue X 100.
COGS(Cost of Goods Sold) is the direct cost your business incurs. It includes the unit cost of each product, labor and fulfillment costs.
Let’s go over a couple of examples to help you get a better grasp of the concept:
Example 1
You are thinking of getting into selling Denim. To test the waters, you purchase one from a supplier for $45 and then sell it to your friend for $72.
Your profit margin would be:
(72 – 45)/72 X 100 = 37.5%.
This means 25% of the $72 for which you sold the product is your profit, while 75% is the cost.
Bear in mind that this is a very basic example, as it didn’t account for costs like shipping, storage, etc. The next example will be more elaborate.
Example 2:
After your initial success selling to your friend, you decide to take things up a notch. So you order 50 pieces of the Denim product, this time at a unit price of $40.
The supplier charges you $165 to ship the entire 50 products to you, plus an extra $75 for the shipping boxes. In addition, you incur $80 to store the product at a mini-warehouse down the street over a 3-month period.
You manage to sell off the entire inventory at an average price of $68. To calculate your margin:
Revenue = 68 X 50 = $3,400
Unit cost of the inventory = 40 X 50 = $2,000
COGS = $2,000 + $165 + $75 + $80 = $2,320
Margin = (3400 – 2320)/3400 X 100 = 31.7%
How to Calculate Selling Price from Profit Margin
In the examples above, the cost(COGS) and selling price(revenue) were both given, allowing you to calculate profit margins.
The question then is, if you knew your cost price and have a particular margin in mind, how would you calculate your selling price?
Thankfully, there is a formula for that, and it is as follows:
Selling Price = Cost/(1 – percentage margin).
For example, if the total unit cost of purchasing an item is $60 and you desire to make a profit margin of 40%, the selling price would be:
Selling Price = 60/(1-0.4) = $100
Getting the idea?
The Profit Margin Calculator
Why spend so much time calculating your profit margin(and probably make mistakes) when you can accurately calculate it with a few taps of the button? This is where the Uphance margin calculator comes in useful.
You simply need to enter your costs and desired markup, and it handles the rest.
We know what you are thinking: how exactly is margin different from markup? Let’s explore their differences in the next section.
Is Margin the Same as Markup?
The simplest answer is no, they aren’t the same thing. The difference is literally in their base point.
While margin is based on the selling price, markup is based on the cost price.
Mathematically, markup = (Selling Price – Cost Price)/Cost Price X 100
For example, if you purchase an item for $50 and sell it for $75, your markup would come out to:
(75-50)/50 X 100 = 50%.
Here’s a breakdown of the differences between margin and markup:
Margin | Markup | |
|---|---|---|
Measured against the selling price | Measured against cost | |
Tells you how profitable your business is | Tells you how to keep your business profitable
| |
The percentage of your revenue that goes into profit | The percentage you need to add to your
COGS to stay profitable
|
Net Profit Margin vs Gross Profit Margin
If you earned, say, $50,000 a year(excluding taxes), that would pass as your gross annual income, right? But if you pay 25% in taxes, your net income would be:
50000 – (0.25 X 50000) = 37,500.
This also applies to gross and net profit margins. However, the “taxes” in this case are the miscellaneous costs that go into running a business, such as marketing, fulfilment, warehousing, etc.
For example, if your total revenue for a year is $75,000 after selling 1,000 units of products with a total cost of $55,000(including labor, supply, and fulfillment), your gross profit margin would be:
Gross Profit Margin = (75000 – 55000)/75000 X 100% = 26.67%
However, if your marketing and overhead costs sum up to $5,000 a year, your net profit margin would be:
Net Profit Margin = (75000 – 55000-5000)/75000 X 100 = 20%
What is a Good Margin for Your Business?
Ideally, what margin should you aim for to keep your business profitable and viable? The answer largely depends on your industry.
If you are in the apparel industry, expect your gross margin to be somewhere in the neighborhood of 54%.
Of course, with the right approach, you can go beyond that figure. This then brings us to the next chapter: how can you improve your profit margin?
How to Improve Your Margins
Looking to improve your margins and make your business more profitable? Here are some creative ways to go about it:
- Adopt competitive pricing
- Streamline your cost
- Utilize AI tools maximally to cut down on labor costs
- Find creative ways to upsell and cross-sell customers
- Bargain for good deals with suppliers
- Go the extra mile to make your customers happy. They will happily come back to buy some more
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