To work out your profit margin there are two main calculations to use depending on whether you want to know your gross profit margin or net profit margin. You can work out gross profit margins by subtracting the cost of goods sold from your total revenue and to work out net profit margins, you should subtract business expenses from total revenue.
While net profit may produce a lower result than gross profit calculations, it’s a more accurate reflection of your business’s overall profitability and bottom line. For this reason, net profit is generally considered to be a better business metric than gross profit.
Learn More About These Key Business Metrics
Whether you’re a business owner, employee or simply love Dragon’s Den, you’ve probably heard the term ‘profit margin’ before, but do you know what it is and how to work it out? In this ultimate guide, we’ll cover everything that you need to know about profit margins – from what they are, to how to increase them so you have the knowledge you need to boost your company’s profits!
How Do You Calculate Profit Margin UK?
There are two main types of profit margins: gross profit margin and net profit margin. Gross profit margin is the percentage of revenue that a company keeps after subtracting the cost of goods sold (COGS). COGS includes all costs associated with making and selling a product or service such as raw materials, labour, and manufacturing overhead. In contrast, the net profit margin is the percentage of revenue that a company keeps after subtracting all expenses. This includes operating expenses, taxes, and interest payments in addition to COGS.
Working Out Gross Profit Margins
The most common way is to take the total revenue generated from sales and subtract the total cost of goods sold (COGS). This will give you the gross profit. From there, you can calculate the profit margin by dividing the gross profit by the total revenue which gives you a profit margin percentage output.
For example, let’s say your business generated £100,000 in sales last year and its COGS were £80,000, your gross profit would be £20,000 and the profit margin would be 20%. To calculate the profit margin you would use the following method:
- £100,000 – £80,000 = £20,000 gross profit
- £20,000 / £100,000 = 20% profit margin.
Working Out Net Profit Margins
The other way to calculate profit margin is to use net income. Your net income is your total revenue minus all expenses. This includes things like operating expenses, taxes, and interest payments. You then need to divide the net income by the total revenue to get the margin percentage.
For example, if your business has a total revenue of £100,000 and expenses of £80,0000, the net income would be £80,000.
- £100,000 – £80,000 = £20,000 net income
- £20,000 / £100,000 = 0.2 profit margin
- 0.2 x 100 = 20% profit margin percentage
These are two of the most common methods to calculate profit margin and if you want your business to increase its profits, it can either raise its prices or lower its COGS (or both).
Why Should You Calculate Profit?
The term “profit margin” refers to the percentage of revenue that a company keeps as profit but why should you calculate business profit? Profit margin is a key metric for all businesses because it tells you how much profit the business is making on each sale and therefore how well it is performing.
A high-profit margin means that a company is efficient and generating a lot of profit per sale. A low-profit margin means that a company is less efficient and could be struggling to make a profit.
Is Gross Or Net Profit A Better Metric?
There are several important metrics to keep track of when running a business but when it comes to profit, is gross profit or net profit more important?
Gross profit is the total revenue from sales minus the cost of goods sold. This metric gives you a good idea of how much profit your business is making on each sale. It doesn’t however take into account other expenses, such as taxes, marketing, and overhead. As a result, gross profit can be deceiving and may not give you an accurate picture of your business’s overall profitability but it is useful if your business goals are focused on increasing revenue.
In contrast, net profit shows the total revenue from sales minus all expenses. This metric gives you a true picture of your business’s bottom line and profitability. While net profit may be lower than gross profit, it’s a more accurate reflection of your business’s profitability. For this reason, net profit is generally considered to be a better business metric than gross profit.
Don’t Forget Your Operating Profit Margin
We’ve covered gross and net profits but there is a third type of profit margin that business owners should be aware of too, the operating profit.
Operating profit margin is a key metric used by investors to evaluate a company’s financial health. It measures the amount of profit generated by a company’s core business operations, relative to its revenue. It is calculated by dividing operating profit by revenue and is a good indicator of a company’s overall profitability and efficiency.
A high operating profit margin indicates that a company is generating a lot of profit from its core business activities. A low operating profit margin indicates that a company is not very efficient or is not generating enough revenue from its core business activities.
How Does It Relate To Gross & Net Profits?
As above, the difference in net profit margin is that this measures the amount of profit generated by a company after taxes and other expenses have been deducted and gross profit margin measures the amount of profit generated by a company before any expenses have been deducted.
While all three metrics are useful for evaluating a company’s profitability, they each provide different insights into a company’s financial health. As such, it is important to understand the difference between operating profit margin, net profit margin, and gross profit margin.
Can You Use Accounting Software For Profits?
Accounting software is designed to help businesses keep track of their finances. By tracking income and expenses, businesses can get a clear picture of their financial health. If you’re using accounting or sales software to monitor and manage your business finances, it should have a built-in profit margin calculator that can do all the work for you.
This information generated in your accounting software can be used to make decisions about where to allocate resources and how to price products and services. Additionally, businesses can use accounting software to track inventory levels and manage customer data. When used effectively, accounting software can help businesses run more efficiently and maximise profits.
If your system can’t calculate your profit margins, you can use an online calculator or do the maths yourself. Just remember to always use the same method so that your margins are consistent over time.
What Is A Good Net Profit Margin?
Profit margins vary greatly between companies and industries, for example, companies in the technology sector typically have much lower margins than companies in the retail sector. As such, you need to keep this in mind when comparing your profit margin with other companies or setting your targets. This will ensure that you’re comparing like for like and setting achievable goals.
Generally speaking, a net profit margin of 5-10% or higher is considered to be good. This means that for every pound of the revenue made, the company gets to keep £0.10 as profit, or that for every £100 made, £10 is profit. A higher net profit margin indicates a more profitable company and gives a company more flexibility in terms of how much it can spend on other things such as advertising, research and development, and expansion.
Regardless of the industry that you operate in, one of your main business goals should be to generate enough profit to cover all expenses and provide a return for investors. A net profit margin of 5-10% is typically seen as a healthy balance between these two objectives.
How To Increase Profits?
It goes without saying that every business owner wants to see their profits increase, and with lots of ways to do this, it can be hard to know where to start!
- To increase profits, try cutting your business costs. This can be achieved by streamlining operations to reduce waste and inefficiencies, improving sales techniques, negotiating better deals with suppliers, or automating certain processes.
- Another way to increase business profits is to increase revenue. This can be done by expanding into new markets, introducing new products or services, or increasing prices.
- For most business owners, the best way to increase profits is usually a combination of both cost-cutting and the company’s revenue-enhancing measures. As every business is unique, you will need to carefully analyse your business metrics and figures to take the best action for you to systematically increase revenue and reduce costs so you stand the best chance of increasing your bottom line.
Margin vs Markup
In business, there are plenty of business terms and acronyms floating around so it’s easy to get some confused with others. Two such terms that often get confused are margin and mark-up, so let’s clear them both up here.
In business, there are two main pricing strategies: margin and markup. Margin is the difference between the selling price of a product and the cost of producing it. Markup, on the other hand, is the amount added to the cost of a product to cover overhead and generate profit. Both margin and markup are valid pricing strategies, but which one is right for your business depends on many factors.
There are pros and cons to both margin and markup. With margin, businesses have a more precise way of calculating their profits. They know exactly how much profit they’re making on each sale, which can be helpful for budgeting and planning purposes. On the other hand, markup is simpler to calculate, since it’s just a matter of adding a fixed percentage (or dollar amount) to the cost of the product. This can make pricing quicker and easier, especially for businesses that sell a lot of different products.
Which Pricing Strategy Should You Use?
If you’re selling products with a wide range of prices, markup may be a better option. This is because it’s easier to calculate a percentage increase than it is to calculate a margin for each individual product.
For example, if you’re selling shirts for £20 each, you can add a 20% markup to cover your costs and generate profit. On the other hand, if you’re selling both £20 shirts and £200 dresses, it’s harder to maintain a consistent margin across all products. As a result, markup may give you more flexibility in pricing.
On the other hand, the margin may be a better option if you have tight control over your costs. This is because calculating margins give you a more accurate picture of your profitability. For example, if your cost of goods sold (COGS) is £100 and you sell the product for £120, your margin is 20%. However, if your COGS increase to £110 without changing the selling price, your margin drops to 18.2%. This shows that even a small increase in costs can have a big impact on profitability.
If you’re not sure which pricing strategy to use, it’s a good idea to try out both and see which one works better for your business. The most important thing is to make sure that you’re covering your costs and generating enough profit to keep your business running.
You should now know the difference between gross profit margins, net profit margins and operating profit margins. You will understand what they are, how to calculate them, how to increase them, and how they impact your business.
While all three profit metrics are useful for evaluating a company’s profitability, they each provide different insights into a company’s financial health. As such, it is important to understand the difference between operating profit margin, net profit margin, and gross profit margin and how you can use these financial reporting figures to evaluate and gross your business success.
Regardless of your profit reporting metrics, you should aim to generate enough profit to cover all expenses and provide a return for investors. A net profit margin of 5-10% is typically seen as a healthy balance between generating enough profit to cover all expenses and providing a return on investment.