The meaning of profit margin is the difference between the sale price and all the fixed and variable costs involved in the marketing process and in the maintenance of the company. Knowing the profit margin will be important in business planning.
Types of profit margin
Basically you have to distinguish between two types of profit margin:
- Gross profit margin: is the price of an item after deducting direct and indirect manufacturing costs. In the case of a service, it would be the remainder of the amount paid for the task after deducting the different costs for its execution.
- Net profit margin: it is the figure achieved by a company after paying the different expenses and taxes. Besides production costs that directly affect the value of the item, the money paid for rent, electricity, water, tax revenues and bank loans must also be taken into account.
How to calculate profit margin
To obtain the gross profit margin, the following formula must be carried out:
Margin = total revenue - cost of services or products sold.
Percentage gross margin is obtained as follows: gross profit / total revenue x 100.
If a company, for example, invoices 50.000 euros per year and presents as costes 6.000 euros in three employees, 5.000 thousand in materials and 1.000 of freight and transportation, to calculate the gross profit you have to subtract the expenses added to the total income. This would be: 50.000 - 12.000 = 38.000 would be the gross profit.
To obtain the net profit you have to add the rest of your fixed costs and variables. For example, 3.000 euros for rent, 2.500 for taxes and 1.000 euros for electricity, telephone and other expenses. Therefore, these 6.500 euros would have to be subtracted from the 38.000 euros of gross income. The result would therefore be 31,500 euros.