Profit Margins Made Simple



It is important that small business owners understand how to calculate profit so they can

work out how well their business is performing. Whatever your business specialises in, all

small businesses need to make a profit in order to be successful.


Understanding how to calculate profit will enable you to increase the profitability of your

business. You can use profit margin to do many things, such as manage your costs, increase

efficiency and identify new business opportunities.

In this article, we will help to get you started with profit margins.


Why Should You Calculate Profit?


There are many reasons why it is a good idea to calculate profit. First and foremost, it is one

of the main indicators of business performance. As money goes into and comes out of the

business, it is not always clear how much you are making. However, by calculating your

profit over a set period of time, you can keep a close eye on your business’s financial health.


Imagine you are making lots of sales. From the outside, it will look like your business is

excelling financially. However, when calculating your profit margin, you may discover that

your business isn’t doing as well as you initially thought.


This would show you that it would be a good idea to cut down your costs in the areas that

you are able to, such as transportation costs or costs of equipment and materials.

Calculating your profit will also be useful if you are looking to expand your business. The

The healthier your profit is, the more you will be able to invest in growth.

It is also helpful to calculate profit in times of high inflation as you will understand how to

confront increasing costs.


How are Gross Profit and Net Profit Different?


  • Gross profit is total sales – direct costs. Direct costs are the costs of selling your service or making your product. It includes the cost of your transportation, materials and your employees’ wages. Gross profit = sales – direct costs

  • Net profit is how much you’ve earned after you’ve taken away your operating expenses, which includes insurance, rent and sometimes taxes. Net profit = sales – (direct costs + operating expenses)


What is Operating Profit?


Operating profit is your income from sales after subtracting operating expenses such as rent

and payroll. It also excludes interest, taxes or profit and loss from

investments.


Operating profit considers non-cash expenses (depreciation and amortization). Calculating

operating profit is a useful way to understand the efficiency of your business operations

before tax. It can also show whether your pricing strategy is correct and how effectively you

are managing costs.


The formula for operating profit = gross profit – operating expenses


What is Profit Margin?


Profit margin is a percentage rather than a figure in pounds. Although profit margin pretty

much tells you the same as the calculations above, it will come in handy when comparing

your performance to other companies.


How Do I Calculate Profit Margin?

  • Gross profit margin = (gross profit/sales) x 100

  • Net profit margin = (net profit/sales) x 100

  • Operating profit margin = (operating profit ÷ revenue) x 100


How Can I Improve My Profit Margin?


The main ways businesses look to improve their profit margin is by…

o Reducing their costs

o Increasing productivity

o Increasing turnover


The Bottom Line


Understanding and utilising profit margins in your business can be a dramatic help when it

comes to understanding how your business is performing. Knowing how your business is

performing will enable you to work out the next steps within your business and how you can

increase your chances of success.


Thank you for reading this article and we hope you have found it useful. If you liked this,

please consider taking a look at our other articles. We talk about a wide range of topics and

they are all focused on expanding your business knowledge. So if you are looking to expand

your business brain, what are you waiting for?