The profit margin is a percentage that shows how much you’re earning in your business overall or per sale.
A business’s key goal is to make money. Otherwise what you’re doing can be classified as a hobby. Read more about the difference between hobby or business.
The higher the profit margin, the more money you’re left with.
How profit margin works
You can think of the profit margin as a number that represents how many cents of profit you generate for every dollar of sales. For example, a 35% margin means your business makes $0.35 profit from each dollar of sales.
If you sell for $50 000 in a year, you’d make $17 500 in profit.
While looking at revenue—what you earn from sales—and earnings—revenue minus cost—are useful figures, the profit margin offers a more accurate view of how your business is doing across different periods.
It’s an indicator used by banks, investors, and other businesses to figure out your business’ financial health, how well it’s run, and whether it’s got potential to grow.
However, keep in mind that industries with low-profit margins, like retail and transportation, might still be profitable because they have a high turnover and a lot of revenue. In this case many little streams make a big river. Keep this in mind if you’re comparing profit margins across different industries.
Different types of margins
There are several types of profit margins, but the most important is the net profit margin, which is calculated by deducting all expenses, including taxes.
These are some other types of margin:
- Gross profit margin: Revenue minus the direct costs of producing goods or services, also called variable costs.
- Operating profit margin: Gross profit minus indirect costs like overhead, advertising, research and development. This is also called fixed costs.
- Pre-tax profit margin: Operating profit plus or minus interest and any unusual charges.