Income
Profit Margin: Definition & Example
Also called: Gross margin, Net margin
What Is Profit Margin?
Profit margin is profit as a percentage of revenue. Gross margin subtracts only the direct cost of what was sold; net margin subtracts every expense.
What does profit margin mean?
Gross margin is revenue minus the cost of goods sold, divided by revenue. A product sold for $60 that cost $40 has a $20 gross profit and a 33.3% gross margin. Net margin goes further and subtracts rent, payroll, interest, taxes, and every other expense, so it is always lower.
To price for a target margin, divide the cost by 1 minus the margin. A 40% margin on a $40 cost needs a price of $40 ÷ 0.6 = $66.67. Adding 40% to the cost gives $56, which is only a 28.6% margin.
Margins matter when a business owner applies for a loan or a lease. Bank statement lenders often assume a flat expense ratio, commonly 50%, against business deposits unless the borrower shows a lower one. A business running a 30% net margin on $20,000 a month of revenue earns about $6,000 a month, not $20,000.
Profit margin example
A bakery has $45,000 in monthly sales. Ingredients and packaging cost $15,750, leaving $29,250 of gross profit: a 65% gross margin. After rent, payroll, and other expenses of $24,750, net profit is $4,500, a 10% net margin.
Profit Margin Calculator
Open the full profit margin calculatorRelated terms
- MarkupMarkup is the amount added to the cost of a product or service to set its selling price, usually stated as a percentage of the cost.
- Break-Even PointThe break-even point is the level of sales at which a business’s revenue exactly covers its costs, so it makes neither a profit nor a loss.
- Net IncomeNet income is what remains after deductions. For a person, it is take-home pay after taxes and withholdings. For a business, it is profit after all expenses.
- Self-Employment IncomeSelf-employment income is money earned from running your own business or working as an independent contractor, measured as business revenue minus business expenses.
- Cash FlowCash flow is the movement of money into and out of an account, household, business, or property over a period. Positive cash flow means more money came in than went out.
Profit margin FAQ
- How do you calculate profit margin?
- Subtract costs from revenue to get profit, divide the profit by revenue, and multiply by 100. $20 of profit on a $60 sale is a 33.3% margin.
- What is a good profit margin?
- It depends on the industry. Grocery stores and restaurants often run net margins in the low single digits, while software and professional services run much higher. Compare against similar businesses rather than one rule of thumb.
- Is gross margin the same as markup?
- No. Gross margin divides profit by the selling price, and markup divides it by the cost. A 50% margin equals a 100% markup.
