Profit margin definition and formula — What is a good margin for a business?

Every successful business has one thing in common: they know their numbers. Among the many numbers that could define a business, profit margins stand out as one of the most important measures of a company’s financial health. 

Whether you are running a startup or a more established enterprise, understanding how to calculate profit margins and what is a “good” margin can give you the competitive edge you need to refine your strategies in an informed way. 

In this article, we’ll go over the essentials, from the definition of profit margins to different types of profit margins, how to compute them, and ways to improve.

What is profit margin?

Profit margin is a financial indicator that measures the percentage of revenue a business keeps (in profit) after all costs have been deducted. It gives a clear view of how much of every dollar in sales turns into profit after covering any expenses.

Profit margin is more than just a number or a percentage; it is an important indicator of how healthy a company is, its operating efficiency and, more importantly for investors, its growth potential. A strong profit margin can help enhance a company’s credibility, helping it attract investors, secure loans, and stay competitive.

Types of profit margins

There are different types of profit margins that can be calculated, with each providing a different insight into a company’s financials. While all are focused on profitability, each type of profit margin gives a different perspective on it.

Gross profit margins

• Definition: Gross profit margin is the revenue left after subtracting the direct costs of producing and/or delivering a product (such as materials or labor, which is also called the cost of goods sold, or COGS).
• Why it is important: Gross profit margin is important because it shows how well a company manages its production and labor costs, and the efficiency of their pricing strategy. It gives companies a good metric to review their products directly to their production costs and helps them revise their pricing or production strategy

Formula:

Operating profit margins

• Definition: Operating profit margin is a measure of the profit after taking account of most operating expenses but not including any interest or taxes.
• Why it is important: Operating profit margin is an important measure of a company’s earning potential and how efficiently it can generate a profit. It is also a useful way of comparing business in the same industry, but under different tax jurisdictions and different loan structures.

Net profit margins

• Definition: Net profit margin is the percentage of the revenue left after every expense has been accounted for, including operating costs, taxes, COGS, and interest.
• Why it is important: Net profit margin is important because it is viewed as the “bottom line” in the measure of a company’s profitability and efficiency. It gives a good view of how lean a company is, how much it is making, and its true capability to generate income.

Why is it important to know how to calculate profit margin?

Calculating and knowing your profit margins is important because it allows you to:

• Measure profitability: You get a good metric to evaluate how effectively your business is turning revenue to profit and the efficiency of your pricing and cost strategies.
• Compare performance: You can track your profit margins over time to see how well they are increasing or decreasing, giving you good insight on areas that may need attention (for example, rising costs).
• Attract Investors and Loans: Healthy profits margins are a sign of a growing business, and potential investors or lenders often review margins to assess your business before investing or lending.
• Benchmarking: Profits margins are also a good metric to compare your company with others in your industry, helping you make better decisions around pricing, expansion, or cost-cutting measures.

How to calculate profit margin

Almost all profit margin formulas follow the same basic principle:

Where depending on the type of profit margin, “Profit” can either be gross profit, operating profit, or net profit. Here is a simple step-by-step approach:

1. Calculate the total revenue: This is the sum of all sales or income generated by the company.
2. Subtract relevant costs: For gross margin, subtract the direct costs to make the goods (COGS). For operating margin, subtract COGS and any additional operating expenses (excluding taxes and interest). For net margin, subtract all expenses (including taxes and interest).
3. Divide by total revenue: Divide the profit amount calculated above by your total revenue to see how much of each dollar in revenue remains.
4. Multiply by 100: Convert the margin to a percentage.

If you’d like a hands-on tool, check out this free profit margin calculator to quickly gauge your numbers by inputting the cost of goods and your markup.

You can also take the formulas above and build out an Excel or Google Sheet, customizing them to fit your needs.

Net profit margin vs gross profit margin

• Gross profit margin: Focuses on direct costs for producing or acquiring products and the income you generate from product sales.
• Net profit margin: Includes all business costs (including labor, office, property, interest, taxes, etc.) and is often the “bottom line” in determining overall profitability.

Why does this matter?

• Short-term product strategy: Gross margin helps you strategize your product pricing and costing. It gives insight into how your product can be priced better, or how you can adjust your materials or labor costs more efficiently to generate higher revenue with lower costs.
• Long-term business strategy: Net margin helps look at the long-term business model and whether it is sustainable, factoring in both revenue and cost of goods, but also overall business expenses.

It is important to examine both the gross and net margins because they give you a deeper understanding of how each part of your operations is affecting profitability. You could be making healthy profit margins on each product you sell, showing healthy gross profit margins, but if your office costs are extremely high, you could have very little net profits.

Thus, it is important to factor in both when focusing on your overall business strategy.

Factors that affect net profit margin

There are many important elements that can influence your net profit margin:

1. Pricing strategy. An efficient pricing strategy is important for a healthy balance. If your prices are too low, you might struggle to recover operating expenses. But if your prices are too high, you could risk losing customers.

2. Cost of Goods Sold (COGS). Rising costs of raw materials and inefficient manufacturing or procurement processes can lead to higher cost of goods sold (COGS), reducing your overall net profit margin.

3. Operational efficiency. If you have high administrative or production costs, they can establish a big overhead and eat into profits. It’s important to streamline your processes and make sure your operational expenses are as lean as possible. An online store can enhance operational efficiency by automating certain tasks, reducing the need for physical storefronts, and reaching a broader audience.

4. Market competition. It’s important to maintain a unique value proposition in highly competitive industries to retain and grow your customer base, which can affect your overall net profits.

5. External factors. From government regulations to economic conditions and market trends, external factors often play a significant role in driving up costs or limiting revenue potential.

Examples of realistic profit margins

Profit margins can vary widely by industry. Below are two examples from the US, one for high-profit margin industries in the US, and another for low-profit margin industries, showing average figures as of January 2025. It is important to note that actual figures can differ depending on geographic location, competition, and specific business models.

High-profit margin industries (Source)

Low-profit margin industries (Source)

These figures are a snapshot in time and general guidelines. A “good” profit margin depends on your unique business model, pricing and cost structure, market conditions, and more. For more context, you can refer to full:ratio’s Profit Margin by Industry.

How to improve profit margin

If your business’ profit margin isn’t where you want it to be, here are some tips you can use to help improve on them:

1. Review pricing strategies. Conduct thorough market research to find appropriate pricing for your products, maximizing profit and earning potential.

2. Reduce operating costs. Review suppliers and workflow, work to negotiate better rates in bulk with suppliers, optimize workflow, and incorporate automation tools (even AI tools) where possible.

3. Increase productivity. Invest in improved employee processes and employee training to enhance efficiency and productivity.

4. Focus on high-margin products. Identify top-performing, high-margin products in your business to prioritize them and to allocate appropriate resources.

5. Optimize inventory management. Work to better forecast inventory management to reduce waste and minimize stock shortages or overstocking.

6. Leverage technology. Use technology where feasible to automate and streamline business processes, from accounting, project management, and customer engagement to asset and vendor management and more.

Streamlining a business is not an easy task, but small, incremental changes in these areas can lead to significant improvements in your margin and profit over time.

Other important performance metrics any business should know

In addition to calculating your profit margin, there are also other important metrics to consider and to get a complete overview of your business’ health:

1. Return on Investment (ROI): Gives a measure of how much profit you earn for every dollar invested back into the business.

2. Customer Acquisition Cost (CAC): Gives an estimate of how much you spend (whether on marketing or discounts or more) to get a new customer.

3. Lifetime Value (LTV): This is an estimate of the total revenue a single customer can bring in over the course of their entire relationship with your business.

4. Break-even point: Where your revenue fully covers all your costs (both fixed and variable).

5. Cash flow: The net amount of cash moving in and out of your business.

Depending on the industry your business is in, some of these may be more relevant and important than others. It is important to thoroughly understand the implications of each metric when you start your business, and how you can utilize them to gain better insight into your business and operations.

FAQs about profit margins

What does gross margin tell you?

Gross margin is an indicator of how effectively your business is managing the costs of the products or services you offer. A higher gross margin would suggest better control on costs or a strong pricing strategy, while a lower gross margin could be a signal to revisit pricing and costs.

What is a good profit margin for reselling?

A “good” profit margin for reselling varies a lot by industry and type of product or service. However, many resellers aim for margins of 25% to 50% of the purchase price, depending on whether it is a product or service, how easily it can be obtained, and any other value additions. If you’re dealing with more specialized or luxury items, you may be able to maintain higher margins, while commodity items often see lower margins in general.

What is a normal profit for a small business?

Profitability for small businesses can differ based on the industry, market trends, location, and overhead costs, but for many small businesses, a net profit margin between 7% and 10% is often considered healthy and reasonable.

What is the most profitable product to sell?

It depends on the industry you are in and the market trends and demands. Generally, digital products (like software, services, online courses, etc.) offer higher margins because the cost of goods sold is relatively low, with little overhead. But having unique offerings and conducting strong market research is important to have a sustainable business so you can check our guide on how to sell online before taking the leap.

What product has the highest profit margin?

Products with lower production costs and high perceived value - like premium cosmetics, designer clothing and accessories, or specialty food items - often yield higher profit margins because of the difference in production costs and retail value. Digital products, like software, also often have higher profit margins because of lower costs of production and distribution, and a higher chance of offering a unique value addition.

Which industry has the highest profit margin?

Historically, financial services and software businesses often have some of the highest profit margins due to relatively lower overhead costs and high value services. The gross margin vs net margin in these sectors tends to be more favorable, especially because they do not rely on expensive raw materials or production processes. If you don’t know where to start, explore some fantastic business ideas to spark some inspiration.

By tracking, monitoring, and fine-tuning your business processes, and thereby your profit margins, you’ll be in a better position to remain competitive in your industry, attract investment, and keep your business growing at a healthy rate. Having a good understanding of how to determine profit margins, along with knowing how to leverage different types of profit margins (net profit margin vs gross profit margin) in your strategic planning, can make a big difference when it comes to scaling up or staying afloat in challenging economic times.