How to calculate profit margin, with examples

The profit margin formula

Margin answers one question. Out of every unit of money a customer pays, how much is profit? The formula has 2 steps.

• Profit = selling price minus cost
• Margin % = profit / selling price x 100

All figures in this guide are USD. Take a product that costs USD 40.00 and sells for USD 60.00. Profit is 60.00 minus 40.00, which is USD 20.00. Margin is 20.00 / 60.00 x 100, which is 33.33%. Put another way, a third of the price is profit and two thirds pays for the product.

The same numbers give a markup of 50.00%, because markup divides the profit by the cost instead of the price: 20.00 / 40.00 x 100. Margin is always the smaller of the two figures. The gap between them catches many people out, and our guide to markup vs margin covers it in full.

Working back from a target margin to a price

Often the question runs the other way. You know the cost and the margin you want, and you need the price. The formula is price = cost / (1 minus margin), with the margin written as a decimal.

With a cost of USD 40.00 and a target margin of 40%, the price is 40.00 / (1 minus 0.40), which is 40.00 / 0.60, or USD 66.67. To check it, profit is 66.67 minus 40.00, which is USD 26.67, and 26.67 / 66.67 x 100 is 40.00%. The markup on that same price is 66.67%.

A tempting shortcut is to add 40% to the cost. That gives a price of USD 56.00, which is a margin of only 28.57%. Adding a percentage to the cost is a markup, not a margin, so the shortcut always lands below the target.

The margin can never reach 100%, because that would need a cost of zero. A 50% margin needs a price of twice the cost, and a 75% margin needs a price of 4 times the cost.

Gross margin and net margin

Gross margin counts only the direct cost of what was sold, such as stock, ingredients, or materials. Net margin also takes off the running costs of the business, such as rent, wages, and utilities. Both use the same formula. They differ only in which costs go into it.

Picture a small cafe over one month. It takes USD 20,000.00 in sales. Coffee, milk, food, and cups cost USD 6,000.00. Rent is USD 3,000.00, wages are USD 8,000.00, and other running costs come to USD 1,000.00.

A 70% gross margin sounds generous, yet the cafe keeps 10 cents of each dollar once the rent and staff are paid. Both numbers are useful. Gross margin shows whether the menu is priced well against the cost of ingredients. Net margin shows whether the business as a whole makes money. A simple net margin often leaves out tax on profit and loan interest, so it helps to say which costs were included when comparing figures.

How margins vary between industries

People often ask what a good profit margin is. There is no single answer, because margins depend on the industry, the size of the business, and the local market. A business that sells large volumes of low cost goods, such as a grocery store, tends to run on thin margins. A business that sells time or expertise, such as a consultancy or a software company, often has much higher gross margins, because its direct costs are small.

We do not publish a table of typical margins by sector, because the figures change by country and by year, and sources define margin in different ways. For a benchmark, look for published data from a trade association in your industry, your national statistics office, or an accountant who works with similar businesses. Compare like with like: gross with gross, and net with net.

Your own history is often the most useful benchmark of all. A margin that slips from one quarter to the next says more about your business than an industry average does.

Three common profit margin mistakes

Confusing margin with markup. As shown above, adding 40% to the cost gives a 28.57% margin, not 40%. Pricing with the wrong figure leaves money behind on every sale.

Including sales tax in the price. Tax collected on a sale belongs to the tax authority, not the business. Suppose the product above sells for USD 72.00 including VAT at 20%. The price before tax is 72.00 / 1.20, which is USD 60.00. Working the margin on 72.00 gives 44.44%, but the true figure is 33.33%. The VAT and GST calculator takes the tax out of a price in one step.

Forgetting payment fees. Card processors and marketplaces often take a percentage of each sale. If a provider charges 3% of the USD 60.00 price, the fee is USD 1.80. The real cost becomes USD 41.80, and the margin falls from 33.33% to 30.33%.

From margin to break even

Margin tells you how much each sale contributes. The next question is how many sales it takes to cover the fixed costs, and the break even calculator answers that. In its bakery example, each unit sells for USD 50.00 and costs USD 30.00 to make, so each sale contributes USD 20.00. With USD 12,000.00 of fixed costs a month, the bakery breaks even at 600 units, or USD 30,000.00 of sales. The break even analysis guide takes the same bakery further.

Profit margin questions, answered briefly

Is profit margin the same as gross margin? Not always. Profit margin on a single product or sale is usually a gross figure. When people talk about a company's profit margin, they often mean net margin. Naming which one you mean avoids confusion.

Can a profit margin be negative? Yes. If the cost is higher than the price, the profit is negative and so is the margin. A product that costs USD 40.00 and sells for USD 35.00 has a margin of minus 14.29%.

Does shipping belong in the cost? Any cost you pay to make a sale happen belongs in the cost per unit, so shipping you pay for counts. If the customer pays for shipping separately, it stays out of both the price and the cost.

Work out a margin with the profit margin calculator