A profit margin is one of the most common metrics used to assess the health and sustainability of a business, but it is also one of the most important. In simple terms, your profit margin is the percentage of your sales revenue that ends up as profit when also accounting for the costs of labour, inventory and business operation. Your profit margin shows how much money your business really makes, demonstrating its overall financial health.

Knowing your sales and profit numbers is extremely important for the daily and long-term running of a business. You can’t make the right decisions about growth without knowing the margins you’re currently working with. So before you can maximise your margins, you have to figure out what they are. This comes down to two main profit metrics: gross profit margin, and net profit margin.

Your gross profit margin is the amount of profit you earn after you’ve accounted for the cost of your services or goods, based on how much you sell them for. The formula for gross profit margin is:

(Revenue – Cost of Goods Solds) / Revenue x 100

For example, say you run a pest control business and your hourly rate is $35. You have a two-hour job where you also have to factor in $15 for your materials, making your direct cost of goods sold $85. If you charged $125 for this particular job, your margin would be:

(125 - 85 / 125) x 100 = 32%

In this case, you earn 32% of that sale as gross profit. The gross margin is beneficial when analysing the profitability of a particular product or service, knowing how much you earn off of the work you do compared to how much it costs to provide the work. This can help you target low margin services and improve their value. However, it is a less useful metric when evaluating the health of your business as a whole — this is where your net profit margin comes in.

our net profit margin provides a fuller view of your financial situation, taking into account revenue and COGS, but also accounting for all your business and operating expenses. These can include rent, payroll, utility bills, insurance, tax payments and any advertising. The formula for net profit margin is:

(Total Revenue – Total Costs) / Total Revenue x 100

For example, if that same pest control business earned $500,000 in a calendar year, but the combined cost of their labour, rent, inventory and everything else was $430,000, the margin would be:

(500,000 - 430,000) / 500,000 x 100 = 14%

The net profit is always lower than the gross profit, because it has to account for a lot more cost factors. However, this gives a more detailed indication of your business’ financial situation.

We’re glad you asked!

Our blog has a dedicated post which discusses ways for maximising your business profit margins.

Have a read of it here: Learn how to maximise your margins