Gross profit margin, operating profit margin, and net profit margin are three key metrics for any product-based business. They’re also strongly connected to gains in productivity, with efforts to improve productivity linked to high growth in profit margins, according to research published by the Harvard Business Review Press. In short, it’s important to understand how to calculate these measures – or at least understand them when using business intelligence software to review your company’s performance and set targets.
Calculate the Gross Profit Margin of any product or category with a single click using BI Vision.
How to calculate the gross profit margin ratio
Gross profit margin shows how much profit the business has before deducting selling, general and administrative costs. Businesses use it to compare their business model to their competitors. The gross profit margin formula is:
Gross Profit Margin = (Net sales – COGS / Net sales) x 100
Gross profit margin is not the same as gross profit. Gross profit margin is a percentage while gross profit is an absolute dollar amount.
How to calculate operating profit margin
The operating profit margin, also known as return on sales, measures how much profit a company makes on a dollar of sales, after paying for variable costs of production but before paying interest or tax.
Operating Profit Margin = (Operating earnings / Revenue) x 100
This metric is a good indicator of how well the business is managed and how risky it is as it shows the proportion of revenue that is available to cover non-operating costs. Operating margin should be used to benchmark your business to others that operate in the same industry and ideally have similar business models.
How to calculate net profit margin
Net profit margin is one of the most important indicators of a company’s financial performance. It measures how much of each dollar in revenue collected translates into profit.
Net Profit Margin = (Net income / Revenue) x 100
Net profit margin is particularly useful as business owners and investors can compare the profitability of two or more businesses, regardless of size. This is because it is expressed as a percentage instead of a dollar amount.
Calculating profit margins: Grace’s mug factory
Grace is a mug manufacturer and makes mugs of all shapes and sizes. In one month, she sells 15,000 mugs, and has the following financials:
With this, Grace can see how much profit she is truly making by calculating gross profit margin, operating profit margin and net profit margin:
Gross Profit Margin = ((Net sales – COGS) / Net sales) x 100 = ((5000 – 3000)/5000) x 100 = 40%
Operating Profit Margin = (Operating income / Revenue) x 100 = (600/5000) x 100 = 12%
Net Profit Margin = (Net income / Revenue) x 100 = (4000 / 5000) x 100 = 80%
Interrogating margins via business intelligence tools
Unleashed Business Intelligence is a BI toolset that sits on top of Unleashed’s inventory management, sales, and production functions. Because it uses the native data of this core business software it offers an always-up-to-date view on the metrics that matter – including easy access to your margin ratios.
Rather than serving a single snapshot of margins at a given point in time, however, the BI Vision tab lets you interrogate margin data (and much more) effortlessly, along multiple dimensions. For example margin by SKU, margin by product type, margin by region and even margin by salesperson can be analysed at a click, and measured over any time-frame.
This flexibility offers a clear advantage over traditional, time-consuming manual margin calculations for businesses using cloud-based software.
How much profit should manufacturers make?
The million-dollar question “What is a good profit margin?” is not easy to answer. There is no specific number that separates a good profit margin from a bad one. You have to consider the industry you’re in and how old your company is — these two factors play a key role in benchmarking your success.
Which industry are you in?
Some sectors make a higher margin than others because each industry has its own economic factors and circumstances.
For example, Alison owns and runs a brewery and has a net profit margin of 30% this year. Her friend Anna is a bookstore manager and makes a net profit of 53% the same year. Anna’s profit margins might be higher than Alison’s but that doesn’t necessarily mean she’s doing a better job — their profit margins are industry-specific.
When gauging how well you’re performing based on profit margins, research the average profit margins for your industry and your geographic region to get an idea of what to expect, and track you own margins over time.
How old is your company?
Business maturity also plays a role. A new business or one that’s scaling is likely to have higher costs, which can lead to lower profit margins compared to more established companies.
Industry life cycles also play a part. The life cycle is made up of three stages: the growth phase, maturity phase and decline phase. In general, during the growth stage profit margins are very high. This attracts competition and encourages innovation. Eventually, the industry matures and the growth of profit slows, meaning lower net profit margins.