Profit margin tells you how much of each sale you keep. It is one simple number, and it explains a lot: whether your prices are right, which products earn their place and why cash is tight.
The formula
Profit margin = profit ÷ revenue × 100
Revenue is what customers paid you. Profit depends on which costs you take away, which gives you two common margins.
Gross margin
Gross margin counts only the direct cost of what you sold: materials, stock, or the freelancer you paid for that job.
Example. You sell a candle for 20 dollars. The wax, wick, jar and label cost 6 dollars.
- Gross profit: 20 − 6 = 14 dollars.
- Gross margin: 14 ÷ 20 × 100 = 70 percent.
You keep 70 cents of every dollar to pay for everything else.
Net margin
Net margin counts all costs: rent, software, marketing, salaries and tax.
Example. In a month you sell 1,000 candles: 20,000 dollars of revenue. Direct costs are 6,000. Rent, wages, ads and everything else come to 10,000.
- Net profit: 20,000 − 6,000 − 10,000 = 4,000 dollars.
- Net margin: 4,000 ÷ 20,000 × 100 = 20 percent.
Gross margin tells you if each sale is healthy. Net margin tells you if the business is.
Margin vs markup
This is the most common mistake in pricing. Margin is based on the selling price. Markup is based on the cost.
Example. A product costs 10 dollars and you sell it for 15.
- Profit: 5 dollars.
- Markup: 5 ÷ 10 = 50 percent.
- Margin: 5 ÷ 15 = 33 percent.
If you want a 50 percent margin, adding 50 percent to the cost is not enough. You need to double it: cost 10, price 20.
For a service business
Your direct cost is often your own time, or the time of the people who do the work.
Example. A website project sells for 3,000 dollars. A freelancer designer costs 900, and software for the project costs 100.
- Gross profit: 3,000 − 1,000 = 2,000 dollars.
- Gross margin: 67 percent.
If you do the work yourself, count your time at a fair hourly rate. Otherwise every project looks more profitable than it is.
In a spreadsheet
- Column A: revenue. Column B: costs.
- Margin: =(A2-B2)/A2, formatted as a percentage.
- One row per product, service or month.
What to do with the number
- Compare products. Low-margin items may not deserve the shelf space or the time.
- Watch the trend. A margin that slowly falls usually means costs rose and prices did not.
- Check your prices. If margins are thin, it may be time to raise your prices.
Good margins and good cash flow are different things. You need both.