How to calculate profit margin

Published Thursday 23 July 2026

Table of contents

• What is profit margin?
• How to calculate gross profit margin
• How to calculate net profit margin
• How to calculate operating profit margin
• What is a good profit margin?
• Margin vs markup
• How to improve your profit margins
• Track your profit margins with Xero
• FAQs on profit margins

Key takeaways

• Profit margin measures the percentage of revenue left after costs, and it comes in 3 main types: gross, net, and operating.
• Calculating your margins regularly helps you spot trends, set smarter prices, and make confident financial decisions for your business.
• A "good" profit margin depends on your industry; Australian retail businesses typically see 5 to 10%, while professional services often sit between 15 and 20%.
• You can improve your margins by reducing costs, reviewing your pricing strategy, cutting unnecessary expenses, and using accounting software to track performance over time.

What is profit margin?

Profit margin is one of the most useful numbers in your business. It tells you what percentage of your revenue you actually keep as profit after paying your costs.

In simple terms, it shows how efficiently your business turns sales into profit. A higher margin means you're keeping more of every dollar you earn. A lower margin means costs are eating into your revenue.

There are 3 main types of profit margin, and each one gives you a different view of your business finances:

• Gross profit margin shows what's left after you subtract the direct costs of making or delivering your product or service
• Net profit margin accounts for all your expenses, including tax, rent, wages, and interest payments
• Operating profit margin sits between the 2; it includes operating expenses like rent and wages but leaves out tax and interest

Understanding all 3 helps you pinpoint exactly where your money is going and where you can improve. Whether you're running a cafe in Melbourne, a trade business in Brisbane, or a consulting firm in Sydney, knowing your margins puts you in control of your financial performance.

How to calculate gross profit margin

Gross profit margin tells you how much revenue is left after covering the direct costs of producing your goods or services. These direct costs are often called cost of goods sold (COGS), and they include things like raw materials, manufacturing costs, or the wholesale price of products you resell.

Here's the formula:

Gross profit margin = (Revenue - Cost of goods sold) / Revenue x 100

Follow these steps to calculate it:

1. Add up your total revenue for the period.
2. Add up your cost of goods sold for the same period.
3. Subtract COGS from revenue to get your gross profit.
4. Divide your gross profit by revenue.
5. Multiply by 100 to get a percentage.

Here's an example. Say your Australian coffee shop brought in $120,000 in revenue last quarter. Your COGS (coffee beans, milk, cups, food supplies) totalled $45,000.

Gross profit = $120,000 - $45,000 = $75,000

Gross profit margin = $75,000 / $120,000 x 100 = 62.5%

That means for every dollar of revenue, you kept 62.5 cents after covering the direct costs of your products. The remaining 62.5% is available to cover your other business expenses like rent, wages, and utilities.

Gross profit margin is especially useful for understanding whether your pricing covers your production costs. If your gross margin is shrinking over time, it could mean your supplier costs are rising or you need to adjust your prices.

How to calculate net profit margin

Net profit margin gives you the full picture. It shows what percentage of revenue remains after you've paid every single expense, including COGS, operating costs, interest, and tax.

Here's the formula:

Net profit margin = (Revenue - All expenses) / Revenue x 100

Follow these steps:

1. Add up your total revenue for the period.
2. Add up all your expenses: COGS, rent, wages, utilities, insurance, interest, tax, and any other costs.
3. Subtract total expenses from revenue to get your net profit.
4. Divide net profit by revenue.
5. Multiply by 100 to get a percentage.

Using the same coffee shop example, let's say your total expenses for the quarter looked like this:

• COGS: $45,000
• Rent: $15,000
• Wages: $30,000
• Utilities and insurance: $5,000
• Tax and interest: $6,000

Total expenses = $101,000

Net profit = $120,000 - $101,000 = $19,000

Net profit margin = $19,000 / $120,000 x 100 = 15.8%

This means you kept 15.8 cents of every dollar earned after all costs. That's the true bottom line of your business.

Net profit margin is the number most business owners focus on, because it shows what you're actually taking home. It's also the figure banks and investors look at when assessing the financial health of your business. For a broader view, learn how to measure profitability across your entire operation.

How to calculate operating profit margin

Operating profit margin shows how efficiently your core business operations run, before factoring in tax and interest payments. It's useful when you want to assess your day-to-day business performance without the noise of financing costs or tax obligations.

Here's the formula:

Operating profit margin = (Gross profit - Operating expenses) / Revenue x 100

Operating expenses include things like rent, wages, utilities, marketing, and insurance. They don't include tax or interest payments.

Continuing the coffee shop example:

Gross profit = $75,000

Operating expenses (rent + wages + utilities and insurance) = $50,000

Operating profit = $75,000 - $50,000 = $25,000

Operating profit margin = $25,000 / $120,000 x 100 = 20.8%

This metric is particularly helpful when comparing your business against competitors, because it removes differences in tax situations and financing structures. It focuses purely on how well you run your operations.

What is a good profit margin?

There's no single number that counts as a "good" profit margin. It varies significantly depending on your industry, business model, and stage of growth.

As a general guide for Australian businesses, here are some typical net profit margin ranges:

• Retail: 5 to 10%
• Hospitality and food services: 3 to 9%
• Professional services (consulting, accounting, legal): 15 to 20%
• Construction and trades: 5 to 15%
• Software and technology: 20%+

Rather than chasing a specific number, focus on comparing your margin against businesses in your own industry. The Australian Bureau of Statistics publishes industry benchmarks that can give you a useful reference point.

It's also worth tracking your margins over time. A steady or rising margin shows your business is on the right track. A declining margin signals that costs may be creeping up or pricing needs a review.

Margin vs markup

Margin and markup are related but they measure different things. Confusing the 2 is one of the most common pricing mistakes small businesses make.

• Margin is the percentage of the selling price that is profit
• Markup is the percentage added to the cost price to reach the selling price

Here's a quick example. You buy a product for $60 and sell it for $100.

Margin = ($100 - $60) / $100 x 100 = 40%

Markup = ($100 - $60) / $60 x 100 = 66.7%

Same product, same profit in dollars, but very different percentages. The key difference is the base: margin uses the selling price, markup uses the cost price.

If you set your prices using a 40% markup but think you're getting a 40% margin, you'll end up with less profit than expected. Always be clear about which calculation you're using when setting prices or analysing your financials. For a deeper comparison, see margin vs markup.

A simple way to remember: margin is always lower than markup for the same dollar profit, because margin divides by the larger number (selling price) while markup divides by the smaller number (cost price).

How to improve your profit margins

Once you know your margins, you can take steps to grow them. Here are some practical strategies that work for Australian small businesses.

Reduce your cost of goods sold

Look at your direct costs and find ways to bring them down. You could negotiate better rates with suppliers, buy in bulk, or find alternative materials that don't compromise quality. Even small savings on COGS can have a big impact on your gross margin.

Review your pricing

If you haven't reviewed your prices recently, now's a good time. Many small businesses undercharge because they set prices once and never revisit them. Research what competitors charge, factor in your costs, and adjust your prices to reflect the value you provide.

Even a small price increase can significantly improve your margins. For example, raising prices by just 5% on a product with a 10% margin effectively increases your profit by 50%.

Cut unnecessary expenses

Go through your operating expenses line by line. Cancel subscriptions you don't use. Renegotiate contracts for things like insurance, internet, or office supplies. Small reductions across multiple expenses add up quickly.

Upsell and cross-sell

Increasing your average transaction value is one of the fastest ways to boost margins. Offer complementary products or premium versions of what you already sell. Since you've already acquired the customer, the additional revenue comes at a lower cost.

Use accounting software to track margins

You can't improve what you don't measure. Use accounting software to monitor your margins in real time, so you can spot issues early and make adjustments before they become bigger problems. You can also use a free margin calculator to quickly check your numbers.

Track your profit margins with Xero

Keeping on top of your profit margins doesn't have to be complicated. Xero's reporting features let you generate profit and loss reports in a few clicks, so you can see exactly where your money is going. You can track gross, operating, and net margins over any time period and compare performance month to month or year on year.

With everything in one place, you can make faster, more confident decisions about pricing, costs, and growth. Get one month free.

FAQs on profit margins

Here are answers to frequently asked questions about profit margins.

What is the difference between gross and net profit margin?

Gross profit margin only subtracts the direct costs of producing your goods or services (COGS). Net profit margin subtracts all expenses, including operating costs, tax, and interest, giving you the true bottom-line percentage.

How often should you calculate your profit margin?

At a minimum, review your profit margins monthly. If your business has seasonal fluctuations or you're making changes to pricing or costs, checking weekly or fortnightly helps you stay on top of trends.

Can you have a negative profit margin?

Yes. A negative profit margin means your costs exceed your revenue, so your business is making a loss. This can happen during startup phases, seasonal dips, or when unexpected expenses hit. If it continues, it's a signal to review your pricing or reduce costs.

Does GST affect profit margin calculations?

GST shouldn't affect your profit margin if you calculate it correctly. Use GST-exclusive figures for both revenue and expenses. Since GST collected from customers is passed on to the Australian Taxation Office, it's not your income, and GST paid on purchases is claimed back as input tax credits.

What's the easiest way to track profit margins over time?

Use cloud accounting software like Xero to automatically generate profit and loss reports. This saves you from manual spreadsheet calculations and gives you an up-to-date view of your margins whenever you need it.