Learning how to calculate profit margin is a very simple formula. We’ll break this down piece by piece for you.
Revenue – Expenses = Net Income ÷ Revenue = Profit Margin
That’s the simple answer on how to calculate profit margin, but lets look a little deeper. Why would we need to know our profit margin? Well, because it grounds us back to reality. It gives us an accurate depiction as to the amount of expense/risk we take versus the actual profit/reward we keep.
Example Of How To Calculate Profit Margin
In the above example, you can see how to calculate profit. Now lets go further to get our profit margin. To do that, we just use the second half of the formula.
Net Income ÷ Revenue = Profit Margin
So lets see how this works out. Take the net income of $22,938.00 and divide it by the total revenue of $110,000.00 . If you’re following along with your calculator, you’ll see that it comes out to .21 at two decimal places.
What we’re looking for is a percentage of the total revenue. So the answer is already starring right at us, but lets multiply our .21 figure by 100. This is your profit percentage. In this case you’re operating with a 21% profit margin! In many standards, this is a good profit margin.
Again this is to show the total risk you take, from the standpoint of cost of goods and operating expenses, against the total revenue you bring in. This percentage figure can increase or decrease depending on how well you streamline operations.
The lower the percentage number, the worse you’re doing. The Higher the percentage, the better job you’re doing at running the company efficiently.
What Is An Acceptable Profit Margin?
Now that we know how to calculate profit margin, we need to realize that in different industries, an acceptable number will vary. For me personally, I want a bigger number if I am putting my time and money on the line. However if I am more hands off, then 25% is acceptable. But that is just me.
Everyone has their own target to shoot for. Lets look at some of the different industries and the ranges they operate within. This is what an article in Forbes says is the top 10 industries and their profit margins:
- Tobacco: 37.06%
- Transportation (Railroads): 36.64%
- Real Estate (General/Diversified): 31.60%
- Utility (Water): 27.90%
- Software (Entertainment): 26.66%
- Semiconductor: 26.59%
- R.E.I.T.: 25.11%
- Information Services: 24.08%
- Metals & Mining: 22.98%
- Drugs (Pharmaceutical): 22.78%
Now those are just industry averages and each company will vary off the stated number a bit. Now of course they’re looking at very large companies also. Sometimes when you’re running a smaller business, you can get better (or sometimes worse) margins. However, you’re dealing with smaller money also.
30% Profit Margin On $100,000 – Or 30% Profit Margin On $10,000
You could end up with $30,000 or $3,000. Both have the same profit margin. Knowing how to calculate profit margin is critical to dialing in operations. Having a high profit margin is great unless you have very little revenue.
Operations Investigation
We can change our profit margin by changing our operations. You can cut expenses or increase production. Here are some examples:
- Shop insurance rates for a better price. Be sure you maintain adequate coverage, or you could hurt your bottom line via injury or lawsuit.
- Look for unneeded expenses. Are you oversupplied or auto-shipping any items? Storing unneeded supplies doesn’t make you money.
- Are all the employees busy at all times? You own their time, so they need to be actively making you money during those hours.
- Can you remarket or upsell any existing customers? You know your product line better than them, so do you have other products they may find useful? It’s easier to market to existing relationships, than to acquire new ones.
- Are you doing an adequate job on new customer acquisition? Can you streamline that process in any way?
- Can you get a better rate from any of your vendors? Overpaying because a salesperson brings you donuts is dumb, lol.
You get the idea, but depending on your industry, customer demographics, company size, and a host of other factors, you can find many, many ways to improve the bottom line.
Knowing how to calculate profit margin allows you to measure how streamlined you’re running your company. More net income is fantastic, but knowing you have a metric for fine tuning the efficiency of operations means you can make money without increasing expense.
How High
Early on, I never even thought of knowing how to calculate profit margin. I didn’t care I guess. It didn’t cross my mind because I was making over 100% profit margin! I just kept going. Back in the 90’s, flipping homes wasn’t even a term, but that’s what I was doing.
I was buying homes between $25,000 and $125,000. After all cost of materials and expenses, I was killing it in the profit margin arena. I currently have a property that will provide me a profit margin in excess of 5000%.
But remember, profit margin doesn’t reflect a dollar amount of net income. Maybe I only have $100 total expense into the property! Ok, that’s not the case, but you get my point.
Profit Margin In All Business
The above example is based on flipping real estate. Knowing how to calculate profit margin is useful in every business. Even though my profit margin worked out different “per property” and “per year”, it’s still an important metric to judge efficiency. You never know when you look back on past performance, what you may find that can earn you more money in the future.
Analyzing your business operations to improve the bottom line is great for any size business, but the bigger the business (revenue), the more you can add to the net income by making a simple tweak to operations.
Now You Know
I hope this short article helped you understand how to calculate profit margin. It’s a very important metric for growing your company/business. It’s a way to measure your proficiency of operations. Keep Profit vs Wage in mind as you move forward with your entrepreneurial endeavors.
