The one formula behind every margin
Every profit margin is profit divided by revenue, times 100. What changes is which costs you take off before you divide. That's why one business can quote a 40% margin and an 11% margin on the same year's numbers and be telling the truth both times.
Revenue here means net sales: what customers paid after discounts and returns, and before any sales tax or VAT you collect for the government.
You can also run the formula backwards. If you know your cost and the margin you want, divide the cost by 1 minus the margin. A $30 cost at a 40% margin needs a $50 price, because $20 of profit is 40% of $50.
Formula notes
Profit margin = profit / revenue x 100
Gross, operating and net margin
Gross margin takes off only the cost of goods sold: what you paid for the products, or the direct cost of delivering a service. Operating margin also takes off running costs like rent, wages, marketing and software. Net margin goes all the way down, taking off interest and income tax too.
Each one answers a different question. Gross margin tells you whether your pricing works product by product. Operating margin tells you whether the business works. Net margin is the bottom line owners and lenders look at.
Formula notes
Gross margin = (revenue - cost of goods sold) / revenue x 100Operating margin = operating income / revenue x 100Net margin = net income / revenue x 100
Worked case: one year, three margins
Picture a small shop with $200,000 of sales and $120,000 of cost of goods sold. Gross profit is $80,000, a 40% gross margin. Rent, wages and other running costs come to $50,000, which leaves $30,000 of operating income, a 15% operating margin.
Then $2,000 of interest and $5,600 of income tax come off, leaving $22,400 of net income. That's an 11.2% net margin. Same shop, same year, three honest answers.
Calculating margin for a single product
For one product you usually want gross margin, or a contribution margin that also counts the costs that come with each sale. A mug that sells for $20 and costs $8 to make has a 60% gross margin. If a marketplace takes 15% ($3) and shipping costs you $4, only $5 is left, so the contribution margin is 25%.
That second number is the one that tells you whether selling more mugs on that marketplace helps. Our margin calculator runs this kind of per-unit stack, adds fixed costs over your volume and solves the price for a target margin.
Mistakes that make margins look better than they are
The most common one is dividing by cost instead of price. That's markup, and it's always the bigger number. A $60 item sold for $100 is a 40% margin, not 66.67%.
Others are quieter. Leaving out card or platform fees, using prices that still include VAT, and ignoring returns all push the margin up on paper. So does measuring revenue and costs over different periods, like a month of sales against a week of wages.
- Divide by revenue, not by cost.
- Use prices without sales tax or VAT.
- Count fees, shipping and refunds you pay on each sale.
- Match revenue and costs to the same period.
Frequently asked questions
Is gross profit the same as gross margin?
No. Gross profit is a money amount, revenue minus cost of goods sold. Gross margin is that amount as a percentage of revenue, so $80,000 of gross profit on $200,000 of sales is a 40% gross margin.
Which margin should a small business track?
Track gross margin to check pricing and operating or net margin to check the business overall. Watching only gross margin can hide rising rent, wages or fees.
How do I calculate margin on a service?
Use the direct cost of delivering it as the cost of goods, such as contractor hours or materials. A $1,000 job that costs $650 to deliver has a 35% gross margin.
Does profit margin include taxes?
Net margin takes off income tax. Gross and operating margin come before it. None of them should count VAT or sales tax you collect from customers as revenue.
References
These sources support the method or guidance used for Margin Calculator. Verify time-sensitive rules at the source.
Try the calculator
Open Margin Calculator, enter your scenario, and compare its supporting rows with this guide's method and checks.