What is Profit Margin?

Profit margin is the measure of a business, product, service’s profitability. Rather than a dollar amount, profit margin is expressed as a percentage. The higher the number, the more profit the business makes relative to its costs.

Some businesses and products with lower profit margins include:

• Luxury goods. Companies producing high-end and specialty products, like apparel, jewelry and watches, cosmetics, and sportscars, tend to have high profit margins. Because brands that make these products have a reputation for luxury, exclusivity, and status, they can afford to mark up their retail prices significantly, helping them turn a significant profit despite lower sales.

• Software and video games. While game and software developers may spend years perfecting their products, they often enjoy a high profit margin on each copy or license sold thereafter.

• Pharmaceuticals and medical equipment. Similarly, medical equipment and drug companies spend billions up front on research and development, but are eventually able to recoup those costs by selling patent-protected devices and treatments at a significant profit.

Small businesses, including retailers, often look at three types of profit margin:

1. Gross profit margin
2. Operating profit margin
3. Net profit margin

1. Gross profit margin is a type of profit margin that measures the difference between sales revenue and the costs of goods sold (COGS), which includes direct product expenses like raw materials, packaging, and direct labor (i.e., labor related to manufacturing or selling your products).

2. Operating profit margin is similar to gross margin in that it measures revenue against cost of goods sold. However, operating margin also incorporates fixed costs of running your business that aren’t directly related to making your products. This includes rent, office supplies, and other administrative costs.

3. Net profit margin incorporates all of your business expenses, including COGS, administrative costs, taxes, interest, and depreciation. In other words, this ratio compares net income with sales. Net margin comes as close as possible to summing up the financial health of your business in a single figure.