Profit margin calculator

The three profit margin formulas

Every margin is a profit figure divided by revenue and multiplied by 100. What changes is how far down the profit and loss account you go before you stop taking costs off:

• Gross margin % = (revenue − cost of sales) ÷ revenue × 100
• Operating margin % = (gross profit − operating expenses) ÷ revenue × 100
• Net profit margin % = (operating profit − interest − tax) ÷ revenue × 100

In plain words, gross margin is what's left of each pound of sales after paying for the goods or the work itself. Operating margin is what's left once the business has also been run for the period. Net margin is what remains once interest and tax have been paid as well. A 7% net margin means 7p of profit from every £1 a customer pays.

Use revenue without VAT. If you're VAT registered, the VAT on your invoices is collected for HMRC and was never part of your turnover; in the US, leave sales tax out for the same reason.

Worked example

A fictional 45-person kitchen fitting company had the year below. These are the calculator's default figures.

Out of every £100 its customers paid, £60 went on the kitchens and the fitting, £30 on running the company, £3 on interest and tax, and £7 was left for the owners. Laid out like that, one thing is obvious: overheads take more than four times as much of each sale as the profit does.

How to read your margins

Read the three from the top down, because each one isolates a different part of the business:

• Gross margin tests your prices and the direct cost of delivering. If it slips, look at supplier prices, discounts, waste and how long jobs really take.
• Operating margin shows whether the business, as it's run today, covers its overheads. It's the margin managers have most control over.
• Net margin adds the cost of borrowing and tax. Two firms with identical operating margins can end up far apart here if one of them is carrying a large loan.

No single figure counts as a good margin for every business. The comparisons that mean something are your own: the same period last year, your budget, and the trend over twelve months. A falling gross margin with steady overheads points at pricing or direct costs. A steady gross margin with a falling operating margin means overheads are growing faster than sales. Your profit and loss account has the figures for each month.

Common mistakes

• Mixing periods. A year's revenue set against one quarter's overheads gives a margin that looks wonderful and means nothing.
• Moving costs between lines. If fitters' wages sit in cost of sales in March and in overheads in April, gross margin jumps for no real reason. Decide where each cost belongs and keep it there.
• Dividing by cost instead of revenue. Profit divided by cost is markup, which comes out higher whenever there's a profit. The markup calculator converts one to the other.
• Forgetting how the owners are paid. Directors who take dividends rather than a salary make the operating margin look better than it would if the company paid a manager to do the same job.
• Dropping depreciation. Vans and machines wear out, and their cost belongs in the sums, whether it sits in cost of sales or overheads. Operating profit before depreciation and amortisation is EBITDA, and should be labelled that way.