For a business to be successful, managers must know the relationship between costs, revenue and pricing. You have to keep your prices low enough to be competitive. At the same time, prices must be set at a level that allows you to cover costs and leaves room for profit. Profit margin -- or gross-profit margin -- is the ratio of gross profit to revenue. In general, the profit margin is what is left over after the cost of goods is subtracted from revenues.
Profit margin is primarily an analytical tool that tells you if your price markup over the cost of goods is sufficient to cover your operating expenses.
This information in turn allows you to evaluate the impact of price discounts or the relative profitability of different product lines. To find a profit margin, calculate the cost of goods sold -- or COGS. The COGS is equal to the purchase price of goods plus any allowances for breakage and loss. Subtract the COGS from revenue to find the gross profit.
Divide the gross margin by revenues and multiply by to convert to a percentage. This is your profit margin. The asterisk symbol means times -- or multiplied by. A closely related measure is net-profit margin. Net-profit margin is your actual profit after all expenses are deducted. That is, to find net-profit margin, add an allowance for operating costs such as rent, office expenses and taxes to the cost of goods sold to find total cost.
Use the same formula as in the previous step, substituting the total cost for cost of goods sold. Finding both the gross and net-profit margins is useful because it tells you how much money is going to operating expenses and whether your pricing structure is allowing room for profit.
Do not to confuse markup with margin. Profit margin measures refer to actual costs. Markup is a method of setting prices. For example, you might use a percent markup for a good. However, you will find this gives you a profit margin of 33 percent. Thus, you can convert from markup to margin, but the percentages are different even though the dollar amount is the same. He writes about business, personal finance and careers.
Adkins holds master's degrees in history and sociology from Georgia State University. He became a member of the Society of Professional Journalists in Skip to main content. Definition Profit margin -- or gross-profit margin -- is the ratio of gross profit to revenue. Net-Profit Margin A closely related measure is net-profit margin. Markup Do not to confuse markup with margin. References 3 Calculate Now: Suggest an Article Correction.More...