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By using the margin calculators, you can get a gauge of the profitability of a business and, specifically, how well it turns its revenue into profit. Let's go through gross margin, net profit margin and operating profit margin in turn.
Calculating gross margin
Gross margin is commonly used to measure the profitibility of a company's products. The figure demonstrates the percentage of revenue over and above the costs involved in making the product (COGS - cost of goods sold). COGS includes materials and labour involved directly in production.
Formula: Gross margin = (revenue - COGS) ÷ revenue
Example: You sell a product for $60 and your costs to make the product are $40.
Gross margin = (60 - 40) ÷ 60 = 0.33 = 33%
Calculating net profit margin
Net profit margin is used to calculate the percentage of sales revenue that remains as true profit, after all costs and expenses are accounted for. It acts as a measure for the amount of net income (or net profit) a business makes per dollar or pound of revenue earned.
To calculate your net profit margin, take your total revenue figure (all types of income) and deduct your total expenses (tax, labour, materials, advertising, debt repayments, etc) to get your net income (or net profit) figure. Then, you divide that figure by your total sales revenue. For a more in-depth explanation of this, see our article profit margin formula - explained.
Formula: Net profit margin = (total revenue - total expenses) ÷ total sales
Example: Your business took $400,000 in sales revenue last year, plus $40,000 from an investment. You had total expenses of $300,000.
Net profit margin = (440000 - 300000) ÷ 400000 = 0.35 = 35%.
This means that for every $1 of revenue, the business makes $0.35 in net profit.
The website Investopedia has a great article about how to determine what your ideal profit margin should be.
Calculating Operating profit margin
Operating profit margin, also known as return on sales or EBIT margin, is commonly used as a measure of the amount of profit a business makes on a dollar or pound of sales, after costs of production (wages and materials), but before interest and tax.
The difference between gross profit margin and operating profit margin is that the gross profit margin includes direct production costs only (materials, labour involved directly in production), where-as operating profit margin takes into account for all operating expenses (labour, rent, office supplies, utilities, advertising, travel costs, insurance and taxes, etc).
Formula: Operating profit margin = operating income ÷ revenue
Example: Your business took $600,000 in sales revenue last year and had operating expenses of $500,000.
Operating profit margin = (600000 - 500000) ÷ 600000 = 0.17 = 17%.
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