How to calculate your profit margins
You will often hear the words gross profit and gross margin used interchangeably when discussing pricing strategy. While they are both important financial metrics, they are not the same thing.
Gross profit is the amount of revenue a company earns after deducting the cost of goods sold (COGS). It is calculated by subtracting the total cost of goods sold from the total revenue. It represents the amount of money a company has left over to cover its operating expenses and generate profit after accounting for the direct costs associated with producing and selling its products.
Gross margin, on the other hand, is expressed as a percentage and represents the percentage of revenue that a company retains after deducting the cost of goods sold. It is calculated by dividing the gross profit by the total revenue and multiplying the answer by 100. It’s a profitability ratio that measures how efficiently a company is using its resources to produce and sell its products.
Let's look at the basics of calculating your profit margins. This will tell you what portion of your sales revenue is actually profit.
Here is a simple step-by-step guide on how to calculate your profit margins:
Total all your costs. This includes the cost of producing the product, overhead costs such as shipping and marketing, and any other related costs.
Subtract your total costs from the total revenue to get your net profit.
Divide the net profit by the total revenue and multiply the answer by 100 to get your margin percentage.
For instance, if you sold a product for $100, and the cost to produce it was $50, while the marketing and shipping costs were $10 and $5 respectively, your total cost becomes $65. The revenue is still $100, but after deducting the total cost ($65), the net profit is $35. To calculate the profit margin percentage, divide the net profit ($35) by the total revenue ($100) and multiply the answer by 100. This results in a profit margin of 35%. Taking into account overhead costs such as marketing and shipping expenses can provide a more accurate picture of profitability and help businesses make more informed pricing decisions.
