Profit margin is a financial ratio that measures the percentage of revenue a company earns after paying business expenses. Understanding the different types of profit margins and how to compute them can help you assess your company’s financial health, operational efficiency, and potential for growth.
What are Profit Margins?
Profit margin refers to the percentage of revenue a company keeps after paying off its business expenses. The higher your profit margin, the more revenue you retain. Higher margins typically indicate greater efficiency and increased flexibility to reinvest in growth, cover unexpected costs, or increase owner compensation.
Types of Profit Margins
Companies calculate profit margin at three levels, each expressing different levels of depth. Bookkeepers calculate profit margin at three levels: after the cost of goods sold, then after operating expenses, and then after interest and income taxes.
Gross Profit Margin
Gross profit margin is the first profit margin you need to calculate. It represents the percentage of revenue remaining after subtracting the cost of goods sold (COGS), or all costs directly related to producing and manufacturing your product, such as materials and labor.
Your gross profit margin shows you how much of your revenue remains available to cover additional expenses, such as operating expenses, debt repayments, taxes, and asset purchases. It is an effective indicator of financial health in relation to production efficiency.
Having a low gross profit margin from the get-go is a bad sign, as it points to potential difficulty in covering costs beyond production.
To calculate gross profit, subtract COGS from total revenue (or net sales). Then, to calculate gross profit margin, divide gross profit by total revenue and multiply the result by 100.
Gross Profit = Revenue – COGS
Gross Profit Margin =Gross ProfitRevenue 100
Example 1
Company A is a restaurant that generated $80,000 in sales in one month. With a COGS of $26,000, it earned a gross profit of $54,000.
Dividing $54,000 by $80,000 gives 0.675, which, multiplied by 100, returns a gross profit margin of 67.5%.
Example 2
Company B is a small graphic design firm operating remotely. In one month, they earned $12,000 in revenue while incurring only $2,400 in COGS. This resulted in a gross profit of $9,600.
The quotient of $9,600 and $12,000 is 0.8, amounting to a gross profit margin of 80%.
Operating Profit Margin
Operating profit margin reveals how much money remains after accounting for day-to-day operating expenses. This includes costs like rent, utilities, salaries, marketing costs, administrative costs, depreciation expenses, and amortization expenses, but excludes taxes and interest.
The operating profit margin helps bookkeepers assess how well a business is performing before taxes and debt repayments. It’s also a key indicator of operational efficiency. By analyzing this margin, bookkeepers can evaluate whether costs like rent, administrative expenses, and marketing are in proportion to the revenue the business generates.
The formula for operating profit margin is:
Operating Profit = Revenue – COGS – Operating Expenses
Operating Profit Margin =Operating ProfitRevenue 100
Example 1
Let’s return to Company A, which generated $80,000 in sales and $26,000 in COGS, earning a gross profit of $54,000. If it incurred operating expenses worth $45,000, it would have an operating profit of $9,000.
$9,000 divided by $80,000 results in 0.1125, which would translate into an operating profit margin of 11.25%.
Example 2
Again, Company B generated $12,000 in revenue and $2,400 in COGS, amounting to a gross profit of $9,600 and a gross profit margin of 80%. With operating expenses worth $3,200, it would earn an operating profit of $6,400.
Dividing $6,400 by $12,000 returns about 0.533, which translates to an operating profit margin of 53.3%.
Net Profit Margin
The net profit margin represents the company’s bottom line. It shows the company’s ability to generate profit after paying for all necessary expenses, including COGS, operating expenses, and additional expenses like taxes, debt payments, and non-operating expenses.
Net profit margin is widely considered one of the most important financial ratios in business. It reflects a company’s true profitability and helps owners gauge their ability to invest funds toward other helpful activities, such as hiring staff, purchasing assets, repaying debt, or issuing dividends. Lenders and investors also use it to assess a company’s capacity to meet repayment obligations.
The formula for net profit is:
Net Profit = Revenue – COGS – Operating Expenses – Other Expenses – Interest – Taxes
Net Profit Margin =Net ProfitRevenue 100
Example 1
Since Company A generated $80,000 in sales, $26,000 in COGS, and $45,000 in operating expenses, it earned a gross profit of $54,000, which amounted to an operating profit of $9,000. If they incurred interest and tax expenses worth $3,000, their remaining net profit would be $6,000.
$6,000 divided by $80,000 is 0.075, which leaves Company A with a net profit margin of 7.5%.
Example 2
Company B, which had a total revenue of $12,000, a COGS worth $2,400, and operating expenses worth $3,200. It generated $9,600 in gross profit, with a remaining operating profit of $6,400.
If the additional expenses, such as taxes, amortization, and interest, amounted to $800, it would have $5,600 remaining as net profit.
The quotient of $5,600 and $12,000 is 0.467, which would translate to a net profit margin of 46.7%.
Profit Margins in Financial Statements
Bookkeepers typically compute the three types of profit on the income statement. The average multi-step income statement will include a row for gross profit, operating profit (or operating income), and net profit (or net income) to paint a clearer picture of earnings per stage.
However, no official bookkeeping documents require the inclusion of profit margins. Instead, business owners and bookkeepers will compute these ratios to contextualize their profit totals. They show profits in proportion to all revenue generated, revealing your capacity to pay for necessary profit margins.
What Does a Healthy Profit Margin Look Like?
Naturally, higher net profit margins indicate an increased capacity to invest in growth. However, the specific benchmark for a healthy profit margin varies by industry, due to the differences in typical cost structures and expected expenses.
For example, industries such as restaurants, airlines, and agriculture typically have lower profit margins due to higher COGS and operating expenses. In contrast, tech companies, financial services institutions, and legal services generally enjoy higher margins due to lower overhead costs. Some industries, like luxury goods, see higher margins thanks to strong brand power and limited competition, which allows them to charge higher markups.
You should also look at profit margins in contrast to the actual profit generated. For example, while an airline making $10 billion in revenue might have a net profit margin of 5%, it still has a $500 million profit left over to reinvest. Meanwhile, a newbie freelancer with a net profit margin of 40% on $50,000 in revenue would only have a profit of $20,000, which is a much smaller amount to work with.
Because production costs, operating costs, and taxes are unavoidable, it’s mathematically impossible for a legitimate business to achieve a 100% profit margin. In fact, NYU’s 2025 study on profit margins per industry reveals that most businesses never achieve profit margins higher than 50%. The highest sustainable net profit margins typically fall within the 30% to 50% range, while some rare exceptions can go from 70% to 80%.
Average Profit Margins by Industry
Again, it helps to turn to industry averages to benchmark healthy profit margins. Below are a few examples from NYU’s 2025 margins by sector study.
| Industry | Gross Profit Margin | Operating Profit Margin | Net Profit Margin |
| Advertising | 29.91% | 10.90% | 3.00% |
| Auto & Truck | 11.11% | 3.13% | 3.77% |
| Drugs (Pharmaceutical) | 70.30% | 22.81% | 8.90% |
| Engineering/Construction | 14.45% | 5.57% | 2.95% |
| Farming/Agriculture | 14.70% | 7.25% | 4.90% |
| Information Services | 33.82% | 11.54% | 6.23% |
| Insurance (General) | 36.83% | 16.43% | 4.16% |
| Metals & Mining | 34.21% | 22.62% | 7.39% |
| Real Estate (Development) | 35.13% | 14.74% | 11.12% |
| Restaurant/Dining | 32.90% | 15.96% | 10.62% |
| Retail (Automotive) | 22.31% | 6.01% | 3.33% |
| Retail (General) | 32.22% | 6.20% | 4.60% |
| Retail (Grocery and Food) | 26.09% | 3.33% | 1.97% |
| Software (System & Application) | 72.38% | 28.63% | 22.94% |
| Utility (Water) | 58.92% | 33.11% | 21.32% |
Markup vs Profit Margin
While the terms profit margin and markup are related, they reveal different information. A markup is the difference between a product’s final selling price and its actual cost, expressed as a percentage of the cost. Meanwhile, profit margins measure the percentage of revenue a business keeps after paying off all necessary costs.
Businesses can set their price markups, but not their profit margins. While high markups can lead to higher profit margins per unit, overall profit margins also reflect the impact of other factors, such as overhead costs, competition, sales volume, and customer demand.
For example:
- Companies that set high markups might see lower profit margins if competition provides lower-cost options.
- In contrast, monopolies and companies in other low-competition industries enjoy high margins from high markups when there is enough customer demand.
- Some companies can still enjoy high profit margins with low markups if they generate high sales volumes and incur low overhead costs.
Profit Margin vs Profitability
Although profit margin and profitability both look at a business’s capacity to generate profit, they are not the same thing. Profit margins specifically refer to the ratio of total profit kept after expenses to total revenue generated. It measures how efficiently a business generates revenue through its core operations.
Meanwhile, profitability is a broader concept that looks at profit generation capacity from all angles, including equity and assets. Measures of profitability include:
- Net Profit
- Gross Profit Margin
- Operating Profit Margin
- Return on Assets (ratio of net income to total assets)
- Return on Equity (ratio of net income to total equity from shareholders)
How to Improve Your Profit Margins
Increasing profitability is a matter of optimizing your selling price, sales volume, and expenses according to customer demand and competition. Below are a few tips for generating your ideal profit margins.
Reduce Overall Operating Costs
Reviewing your operating profit margin helps you understand how much your operating expenses reduce revenue. From this information, identify your specific expenses and assess which ones are necessary and which ones you can reasonably reduce by negotiating, scaling back, downgrading, or removing.
For example, if face-to-face communication is unnecessary for core production and operational activities, switching from an in-office work setup to remote work can help increase savings. By eliminating rent expenses, the business keeps more of its revenue.
Offer Products and Services Based on Demand
Study the products and services in your catalog and assess their contributions to revenue. If there is low demand for a product, discontinuation can help you lower costs.
Musicians, for example, often choose tour stops based on demand. If projected ticket sales in a target location fall short of the expected costs of renting venues, hiring staff, and building production sets, the artist and their team typically elect to cut their losses and skip the stop.
Adjust Your Pricing Strategy
Review your pricing regularly to align with demand and competitor prices. If customers are loyal and see value in your products, you can afford to apply small price increases and improve profit margins.
At the same time, strategic discounts can attract more buyers. If a product has strong demand, lowering its price may boost sales volume without hurting overall profitability. Offering bundle deals on items frequently purchased together can also encourage more sales.
Invest in Marketing
A small marketing push can go a long way in boosting your sales volume, especially with a tight strategy. If you have a target customer, identify their preferred channels of communication and distribute promotional content tailored to their values and preferences. A focused approach helps you guarantee sales while keeping marketing expenses low.
Build Brand Loyalty
Encourage repeat business by engaging customers and creating positive experiences. Loyal customers often spend more and are less sensitive to price changes, which helps maintain healthy profit margins. Offering loyalty programs, providing excellent support, and delivering consistent quality can strengthen relationships and keep sales consistent.
Bottom Line
By learning how to calculate them, you can gain valuable insights into your company’s financial health, operational efficiency, and growth potential. Regularly monitoring these margins empowers you to make informed business decisions that drive profitability and ensure long-term success.
Work with a bookkeeping firm that cares about your growth. The EpicBooks team invests in your success, offering bookkeeping services tailored to the unique demands of your business and industry. It provides everything from tax assistance to financial advisory to standard bookkeeping maintenance.
Check out the EpicBooks pricing page for more information.
