Profit Margin Calculation, Formula, and Examples

There are several financial metrics that investors and analysts use to evaluate the financial health of a company. The profit margin calculation is one of these financial metrics. A company’s profit margin is calculated as the total number of cents per dollar that is earned on a sale that the company keeps as a profit.

As one of the profitability indicators, the profit margin tells us the profitability status of a company; whether the company is making money. It gives an insight into the portion of the company’s sales that is turned into profits and the amount of cents per dollar that the company generates per sale. Hence, it enables analysts and investors to evaluate the financial health and well-being of certain companies. In this article, we will discuss profit margin calculation, types of profit margin calculation formulas, and examples.

Profit margin calculation examples
Profit margin calculation

Related: Income Statement Ratios Formulas and Examples

What is profit margin?

Profit margin is one of the common profitability ratios that are used to gauge the extent to which a company or a business’s activity generates profit. It is a ratio of a company’s profit (sales minus all expenses) divided by its revenue which is always expressed as a percentage. This profitability ratio compares profit to sales and tells us how well a company is handling its overall finances. It shows the percentage of sales that have been turned into profits. Therefore, in simple terms, the profit margin figure shows us in percentage how many cents of profit a business has generated for each dollar of sale.

Take, for instance, a company that reports on its financial statements that it achieved a 35% profit margin during the last quarter; this would mean that the company had a net income of $0.35 for each dollar of sales made. Hence, profit margin calculation is a key business metric used in measuring the success of a business. Calculating a business’s profit margin determines the percentage amount of profit made in comparison to the sales made, or revenue. The profit margin shows the percentage amount rather than the dollar amount for the profit made. Hence, calculating the profit margin of a business can help to make pricing decisions, identify any issues, and ultimately help grow the business.

A company’s profit margin can be calculated by referring to the income statement, a financial statement used by companies to track their income and expenses. As a profitability indicator that shows the overall financial standing of a business, a higher profit margin would indicate success while a lower profit margin would be an indication that changes may be needed to cover expenses. However, the profit margin figure across different industries varies as one figure may be considered a high-profit margin in one industry but a low-profit margin in another.

See also: Float Stocks Calculation and Formula

Types of profit margin calculation

  1. Gross profit margin
  2. Operating profit margin
  3. Pre-tax profit margin
  4. Net profit margin

Listed above are the several types of profit margins or levels of profit. Among these profit margins, the most common one is the net profit margin, which is what is usually referred to as a company’s bottom line. It is the figure that is left after any taxes and any other expenses have been deducted. The levels of profits listed above are reflected on a company’s income statement in the following sequence:

When a company takes in sales revenue and pays direct costs of the product or service, what the company has left is what we refer to as the gross margin. Then, as the company pays indirect costs such as company headquarters, advertising, and R&D, what is left is known as the operating margin. Then when it pays interest on debt and adds or subtracts any unusual charges or inflows unrelated to the company’s core business, what is left is a pre-tax margin. Then it pays taxes and has the net margin left over, which is also known as net income, which is referred to as the bottom line.

Gross profit margin calculation & formula

In order to calculate gross profit margin, start with sales and deduct the costs directly related to creating or providing the product or service such as raw materials, labor, etc. These costs are usually bundled together and listed on the income statement as a line item known as cost of goods sold (COGS), cost of products sold, or cost of sales. Also, service companies, like law firms, can use the cost of revenue (the total cost to achieve a sale) on their income statement rather than the cost of goods sold (COGS).

Gross profit margin calculation formula
Gross profit margin calculation formula

The gross margin calculation is done on a per-product basis and is most useful for a company analyzing its product suite; that is companies use it to compare product lines, such as auto models or cell phones. Hence, the gross profit margin calculation compares revenue to variable costs which tells us how much profit each product creates without fixed costs. Therefore, the gross profit margin calculation formula is expressed as:

Gross profit margin = (Gross Profits/Net Sales) x 100

Where,

Gross profit = Revenue – COGS (Direct materials + Direct labor + Factory overhead)

Net sales = Total revenue

Hence, Gross profit margin = {(Net sales − COGS)/ Net sales} x 100

Therefore, in order to calculate the gross profit margin, you have to know how much the item sells for (revenue) and how much it costs (COGS) to make the item. For instance, Mary sells a shirt for $25 and it costs her $15 dollars to make the shirt. The $15 is the COGS, hence, to calculate her gross profit margin, she will have to plug her totals into the gross profit margin calculation formula below:

Gross profit margin = {(Net sales − COGS)/ Net sales} x 100

Gross profit margin = [($25 – $15) / $25] X 100 = 40%

This means that Mary’s gross profit margin is 40%, or 0.40, telling us that she makes 40% on every shirt that she sells.

Operating profit margin calculation & formula

In order to calculate the operating profit margin (operating margin), start with the company’s gross profit figure and then subtract selling, general and administrative expenses (or operating expenses) from it. This will give you the operating profit margin which is also known as EBIT (earnings before interest and taxes). In this particular profit margin calculation both costs of goods sold, costs associated with selling and administration, and overhead have been deducted from the total revenue.

Operating profit margin calculation formula
Operating profit margin calculation formula

The operating profit margin figure is what is available to pay the business’ debt and equity holders, as well as the tax department. It is the profit from the company’s main, ongoing operations which is usually used by analysts and bankers to value an entire company for potential buyouts. Therefore, the operating profit margin calculation formula is expressed as:

Operating Profit Margin = {Operating Income / Revenue} × 100

For example, let’s say we want to calculate a business’s operating profit margin and the operating income of the business is $20,000 with a revenue of $50,000. Plugging the operating information into the operating profit margin calculation formula will give us:

Operating profit margin = ($20,000 / $50,000) X 100

= 0.4 x 100 = 40%

This means that the business’s operating profit margin is 40% or 0.4.

Pre-tax profit margin calculation & formula

The pretax profit margin calculation is a financial metric that is used to measure the operating efficiency of a company. In order to calculate the pretax profit margin, take the operating income and deduct interest expense while adding any interest income, and then adjust for non-recurring items such as gains or losses from discontinued operations. This will give you the pre-tax profit, or earnings before taxes (EBT) which you have to divide by revenue, to get the pretax profit margin. That is, you subtract the operating and interest costs from the gross profit and divide it by revenue.

Pre-tax profit margin calculation and formula
Pre-tax profit margin calculation formula

Hence, the pretax profit margin calculation formula is expressed as:

Pre-tax profit margin = {Pre-tax income /Revenue} x 100

Or

Pre-tax profit margin = {(Income before taxes)/ Net sales} x 100

If for example, you have sales totaling $500,000, an annual gross profit of $100,000, operating expenses of $50,000, and interest expenses of $10,000. This is how you will calculate your retax profit margin:

First, you will calculate the earnings before taxes (EBT) by subtracting the operating and interest costs from the gross profit. That is, ($100,000 – $60,000) which will give us pretax earnings of $40,000. Since you have a total sales of $500,000 for the fiscal year (FY), your pretax profit margin will be calculated by dividing your pretax earnings by the total sales:

($40,000/$500,000) = 0.08

0.08 x 100 = 8%

This means you will have a pretax profit margin of 8%.

Net profit margin calculation & formula

The net profit margin is the most significant of all the profit margins. In fact, people usually refer to the net profit margin when they ask about a company’s profit margin. Calculating the net profit margin of a company is quite simple. It is calculated by dividing the company’s net profits by net sales, or by dividing the net income by the revenue realized over a given accounting period.

Net profit margin calculation formula
Net profit margin formula

In the context of profit margin calculations, net profit is determined by subtracting all the associated expenses, including costs towards raw materials, labor, operations, rentals, interest payments, and taxes, from the total revenue generated. Hence, the net profit margin calculation formula is expressed as:

Net profit margin = {Net Profits (or Income) / Revenue} x 100

or

Net profit margin (NPM) = {(R − COGS − OE − O − I − T)/ R} x 100

Where,

  • R = Revenue
  • COGS = Cost of goods sold
  • OE = Operating expenses
  • O = Other expenses
  • I = Interest
  • T = Taxes

As you can see from the net profit margin formula, dividends paid out are not considered an expense, and as such are not considered in the formula.

In order to understand the net profit margin calculation, take for instance a company that has revenue of $20,000 and has total expenses that add up to $10,000 with the breakdown of the following expenses:

  • COGS: $4,000
  • Operating expenses: $3,000
  • Other expenses: $1,500
  • Interest: $500
  • Taxes: $1,000

Let’s plug the pieces of information into our profit margin formula below:

Net Profit Margin = {(Revenue – COGS – Operating Expenses – Other Expenses – Interest – Taxes) / Revenue} x 100

Net Profit Margin = {($20,000 – $4,000 – $3,000 – $1,500 – $500 – $1,000) / $20,000} x100

Net Profit Margin = {($20,000 – $10,000) / $20,000} x 100

= {$10,000 / $20,000} x 100

= 0.50 x 100 = 50%

This means that the company’s net profit margin would be 50%. However, if you already know a company’s net income amount, you can skip the step of subtracting the company’s expenses from revenue and just simply divide the company’s net income by its revenue, then multiply the figure by 100.

Related: Debt to EBITDA ratio formula and calculation

Profit margin calculation examples

Since profit margins vary from industry to industry, a bad profit margin for one company may be considered a good one for another. Hence, a company’s average profit margin depends on a few different factors such as the number of employees that the company has, type of business, business location, size, how the company manages inventory, and its operating systems. Therefore, due to the fact that profit margins vary, you can’t compare companies in different industries, it is best to compare companies in the same industry.

Let’s look at some examples of profit margin calculation of different companies across different industries:

Profit margin calculation example 1: Starbucks (SBUX)

From the income statement of Starbucks for 2021 (source: finance.yahoo.com), it is gathered that Starbucks (SBUX) recorded revenue of $29.06 billion for the fiscal year ending Oct. 3, 2021. The company had a gross profit of $8.391 billion, an operating income of $4.872 billion, $5.356 billion pre-tax income and the net profit for the year was $4.2 billion (all figures have been rounded up). Let’s calculate the gross profit margin, pretax profit margin, operating profit margin, and net profit margin.

Solution

For Gross profit margin calculation,

= (Gross Profit / Net Sales) x 100

= ($8.391 billion/$29.06 billion) × 100

= 0.2887 x 100 = 28.87%

Hence, SBUX had a gross profit margin of 28.87%

For Operating profit margin calculation

= {Operating Income / Revenue} × 100

= ($4.872 billion / $29.06 billion) × 100

= 0.1676 x 100 = 16.76%

Hence, SBUX had an operating profit margin of 16.76%

For Pre-tax profit margin calculation

= {Pre-tax income /Revenue} x 100

= ($5.356 billion/$29.06 billion) × 100

= 0.1843 x 100 = 18.43%

Hence, SBUX had a pre-tax profit margin of 18.43%

For Net profit margin calculation

= {Net Profits / Revenue} x 100

= ($4.2 billion / $29.06 billion)

= 0.1445 × 100 = 14.45%

Hence, SBUX had a net profit margin of 14.45%

This profit margin calculation example shows the importance of having strong gross and operating profit margins. Having weak gross and operating profit margins indicates that money is being lost on basic operations, leaving little income for debt repayments and taxes. Hence, Starbucks having healthy gross and operating profit margins as seen in the above example enabled it to maintain decent profits while still servicing all of its other financial obligations.

Profit margin calculation example 2: Amazon

Using Amazon Income statement for profit margin calculation example
Amazon Income statement
Source: U.S. Securities and Exchange Commission

From the Amazon income statement above we have the following:

  • Net sales- $386,064 million
  • Cost of sales- $233,307 million
  • Income before taxes- $24,178 million
  • Operating income- $22,899 million
  • Net income- $21,331 million

Using the information above here is how to calculate profit margin for Amazon for FY 2020:

Solution

How to calculate profit margin for Amazon:

For Gross profit margin calculation,

= {(Net sales − COGS)/ Net sales} x 100

= {($386,064 million – $233,307 million) / $386,064 million} × 100

= {($152,757 million) / $386,064 million} × 100

= 0.3956 x 100 = 39.56%

Hence, Amazon had a gross profit margin of 39.56%

For Operating profit margin calculation

= {Operating Income / Net sales} × 100

= {$22,899 million / $386,064 million} × 100

= 0.0593 x 100 = 5.93%

Hence, Amazon had an operating profit margin of 5.93%

For Pre-tax profit margin calculation,

= {(Income before taxes)/ Net sales} x 100

= {$24,178 million / $386,064 million} × 100

= 0.0626 x 100 = 6.26%

Hence, Amazon had a pre-tax profit margin of 6.26%

For Net profit margin calculation

= {Net Profits / Revenue} x 100

= ($21,331 million / $386,064 million) x 100

= 0.0552 × 100 = 5.52%

Hence, Amazon had a net profit margin of 5.52%

Profit margin calculation example 3: Tesla

Using Tesla Income statement for profit margin calculation example
Tesla Income Statement
Source: Tesla Form 10-K (Pg 55)

From the Tesla income statement above we have the following figures for the year, 2020:

  • Total revenue – $31,536
  • Cost of revenue- $24,906
  • Gross profit- $6,630
  • Operating income- $1,994
  • Income before taxes- $1,154
  • Net income- $862

Using the information above (all figures above are in millions), here is how to calculate the profit margin for Tesla for FY 2020:

Solution

For Gross profit margin calculation,

= (Gross Profits / Total revenue) x 100

= {$6630 / $31,536} × 100

= 0.2102 x 100 = 21.02%

Hence, Tesla had a gross profit margin of 21.02%

For Operating profit margin calculation

= {Operating Income / Total Revenue} × 100

= {$1,994 / $31,536} × 100

= 0.0632 x 100 = 6.32%

Hence, Tesla had an operating profit margin of 6.32%

For Pre-tax profit margin calculation,

= {(Income before taxes)/ Total revenue} x 100

= {$1,154 / $31,536} × 100

= 0.0365 x 100 = 3.65%

Hence, Tesla had a pre-tax profit margin of 3.65%

For Net profit margin calculation

= {Net Profits / Revenue} x 100

= ($862 / $31,536) x 100

= 0.0273 × 100 = 2.73%

Hence, Tesla had a net profit margin of 2.73%

Profit margin calculation example 4: Coca-cola

Using Coca cola Income statement for profit margin calculation example
Coca-Cola Income Statement
Source: SEC

From the Coca-cola income statement above we have the following figures for 2020:

  • Net revenue – $33,014
  • Cost of goods sold- $13,433
  • Gross profit- $19,581
  • Operating income- $8,997
  • Income before taxes- $9,749
  • Net income- $7,768

Using the information above (all figures above are in millions), here is how to calculate the profit margin for Coca-cola for FY 2020:

Solution

For Gross profit margin calculation,

= (Gross Profits / Net revenue) x 100

= {$19,581 / $33,014} × 100

= 0.5931 x 100 = 59.31%

Hence, Coca-cola had a gross profit margin of 59.31%

For Operating profit margin calculation

= {Operating Income / Net Revenue} × 100

= {$8,997 / $33,014} × 100

= 0.2725 x 100 = 27.25%

Hence, Coca-cola had an operating profit margin of 27.25%

For Pre-tax profit margin calculation,

= {(Income before taxes)/ Net revenue} x 100

= {$9,749 / $33,014} × 100

= 0.2952 x 100 = 29.52%

Hence, Coca-cola had a pre-tax profit margin of 29.52%

For Net profit margin calculation

= {Net Income / Net Revenue} x 100

= ($7,768 / $33,014) x 100

= 0.2352 × 100 = 23.52%

Hence, Coca-cola had a net profit margin of 23.52%

See also: Return on assets formula: ROA calculation

Comparing profit margin

Profit margin cannot be the only metric used for comparison between businesses because each business has its own distinct operations. Therefore, when calculating profit margin, you can’t compare companies in different industries, it is best to compare companies in the same industry. Some business sectors tend to have high-profit margins compared to others such as businesses of luxury goods and high-end accessories, software or gaming companies, and patent-secured businesses like pharmaceuticals. Luxury goods and high-end accessories businesses usually operate on high-profit potential and low sales. This is because, a few costly items, are manufactured after securing the order from a customer, which makes it a low-expense process without many operational overheads.

Similarly, software or gaming companies may invest initially while developing a particular software and later cash in big from simply selling millions of copies with very little expenses. Also, getting into strategic agreements with device manufacturers, like offering pre-installed Windows on Dell-manufactured laptops, further reduces costs while maintaining revenues. This is a similar case for patent-secured businesses like pharmaceuticals which incur high research costs initially, but cash in big later with high-profit margins while selling the patent-protected drugs with no competition.

Furthermore, just as some business sectors tend to have high-profit margins, some tend to have a low-profit margin such as operation-intensive businesses, agriculture-based ventures, and automobiles. Operation-intensive businesses such as transportation may have to struggle with fluctuating fuel prices, vehicle maintenance, and drivers’ perks and retention, and as such usually have lower profit margins.

Similarly, agriculture-based ventures due to weather uncertainty, operational overheads, high inventory, the need for farming and storage space, and resource-intensive activities usually have low-profit margins. Automobile businesses also tend to have low-profit margins, because profits and sales are limited by factors such as uncertain consumer demand, intense competition, and high operational expenses which are involved in developing dealership networks and logistics.

A video explaining profit margin calculation
Obotu Agape Oguche