How to calculate profit margin

Want to know how successful your business is? Learn how to calculate profit margin to gauge your business’ performance using this guide. Find out:

• How to calculate your profit margin
• What profit margins are used for
• How to maximise your profit margin
• How to understand your finances better with Countingup

If you’re launching a new business as a sole trader or company director, you’ll need to know some business basics. Read on to find out more about key financial metrics for businesses and how Countingup can help you understand them better.

Profit margin is the profit your business makes expressed as a percentage.

Depending on which type of profit margin you’d like to calculate (gross or net), the exact figures may change, but the process is largely the same. Find out how to calculate each profit margin type below.

Gross profit is the profit you make directly from your product or service. To calculate your gross profit margin, add all the expenses you need to make your product or provide your service (known as your cost of goods) and subtract them from your total revenue (the total amount of money you receive as income from customers). Make sure to use figures from the same time frame (such as the same week or month) to make your records consistent, at intervals that are suitable for your business needs. 

Gross profit = total revenue – cost of goods

Now, take the figure you’ve just calculated and divide it by your revenue, then multiply by 100.

Net profit is the profit you make after all other business expenses have been accounted for, including electricity, heating, marketing, or payroll.  To calculate your net profit margin, combine all of your expenses (cost of goods, heating, website hosting, taxes, etc.) and subtract this figure from your total income. Similar to before, remember to use the same period of time when calculating your profit figures.

Net profit = total revenue – total expenses

Next, divide your net profit by your total revenue, then multiply by 100.

Note that in each example, your profit margin can be negative. This means your business is losing money. Find out what this means and how you can stop it in the next section. 

Overall, your profit margins tell you how much money you make from each £1 a customer spends. While this is valuable information on its own, you can also use your margin figures to compare strategies across time. Each profit margin type functions differently as they use slightly different numbers. Therefore, you need to know what the numbers actually mean.

Your gross profit margin allows you to understand how much money you make from your product or service. This figure tells you how much money is left over to cover your operational expenses from every £1 your customers spend. Your net profit margin then allows you to understand how much is left over for you, after accounting for all your costs, from that same £1 a customer spends on your business. 

Your net profit is a more comprehensive figure for your business’ health and is typically used more. However, understanding how gross and net profit figures relate is critical as they’re two sides of the same coin. They tell you how each side of your business is performing. 

As your gross profit margin figure is directly tied to your product, you’ll be able to understand how customers are engaging with what you’re selling. In contrast, your net profit margin shows how successful your business is in how you run it. After deducting all your costs, your net profit lets you know how much you can reinvest in business areas going forward.

If your percentage figure is negative when calculating either your gross or net profit margin, this means your business is losing money. Depending on where this happens in your calculations, you’ll be able to detect which expenses are costing you more (cost of goods or operational expenses). It’ll also give you an idea of how much more you have to sell to make your business profitable.

Therefore, using these figures, you’ll be able to detect early successes in strategies you’ve used to grow your business or where you need to adapt your business for future trading.

Maximising your profit margin usually involves increasing your revenue or decreasing your expenses. However, the methods for maximising your gross or net profit vary slightly, as they deal with different sources of expenses.

Strategies for increasing your gross profit margin should focus on your revenue stream. Either by increasing the value of your product and having customers pay more or by reducing the cost it takes for you to provide it in the first place. Here, you could consider using economies of scale by ordering goods expenses for your product or service in bulk or innovating to reduce production costs in other ways.

Your net profit margin can be increased slightly more easily by reducing operating costs. One of the more effective ways of doing this is by shopping around for competitive rates for your expenses and using promotional deals when switching suppliers.

However, not all expenses can be reduced easily as some businesses or industries simply need to grow to a certain size to be profitable. Therefore, consider growth strategies for your business to increase your profit margins as much as cost-reducing ones.

If you’re looking to grow your business, use Countingup to understand your finances better.

Countingup is the business current account and accounting software in one app. With all your financial information in one place, you can automate your accounting admin to save time and stress on running your business. 

The Countingup app comes with key innovative features for new business owners like real-time profit and loss reports, receipt capture tools, expense reminders and tax estimations. These can help you make sure your accounts are up to date, accurate, and completely tax compliant. 

Gain complete confidence in your finances. Find out more here and sign up today for free.