Profit margin: what it is, how to calculate and improve

Published Thursday 16 April 2026

Table of contents

• What is a profit margin?
• Types of profit margins
• Why do profit margins matter?
• How to calculate profit margins
• How to increase your profit margins
• Track your profit margins with Xero
• FAQs on profit margins

Key takeaways

• Calculate your profit margin using the formula (Profit ÷ Revenue) × 100 to measure how efficiently your business turns sales into profit and track financial health over time.
• Monitor all three types of profit margins — gross, operating, and net — as each reveals different insights into your business performance, with net profit margin giving the most complete picture of true profitability.
• Improve your profit margins by focusing on three key areas: controlling operational costs through regular expense reviews, streamlining processes for greater efficiency, and setting prices strategically to maximise revenue while staying competitive.
• Review your profit margins monthly and compare them against industry benchmarks to spot trends, make informed decisions, and direct resources toward your most profitable activities.

Key takeaways

Here are the main points to remember about profit margins:

• Calculate your profit margin using the formula (Profit ÷ Revenue) × 100 to measure how efficiently your business converts sales into profit and track financial health over time.

• Monitor all three types of profit margins (gross, operating, and net) as each provides different insights into your business performance, with net profit margin giving the most comprehensive view of true profitability.

• Improve your profit margins by focusing on three key areas: controlling operational costs through regular expense reviews, streamlining operations for greater efficiency, and implementing strategic pricing that maximises revenue while staying competitive.

• Review your profit margins monthly and compare them against industry benchmarks to identify trends, make informed business decisions, and allocate resources toward your most profitable activities.

What is a profit margin?

Profit margin is the percentage of revenue remaining after deducting business expenses. It measures how efficiently your business converts sales into profit. The higher the percentage, the more money you keep from each sale.

Australian Accounting Standards define profit or loss as the total of income less expenses. Calculating your profit margin helps you analyse expenses and make reliable financial decisions.

A strong profit margin shows your business is financially healthy. It helps you:

• Cover costs: Confirm you generate enough revenue to pay all expenses
• Spot opportunities: Track which areas of your business are most profitable
• Make decisions: Identify where to reduce expenses or invest resources

Profit margins vs net profit

Net profit is the dollar amount left after paying all expenses. Profit margin is that same profit expressed as a percentage of total revenue. For example, if you earn $100,000 revenue with $20,000 net profit, your profit margin is 20%.

Types of profit margins

There are three main types of profit margin:

• Gross profit margin: Measures revenue remaining after paying for goods or services sold. Shows your core product profitability before other expenses.
• Operating profit margin: Measures profit after paying production costs like wages and materials, but before taxes and interest. Shows how efficiently you run day-to-day operations.
• Net profit margin: Measures final profit after all costs and taxes. Shows your true bottom-line profitability and overall financial health.

For more details, learn about net profit margin.

Why do profit margins matter?

Profit margins matter because they reveal whether your business is truly profitable, not just generating revenue. They help you make better decisions across key areas:

• Pricing strategy: Determine if your prices generate adequate returns
• Cost control: Identify areas where expenses are eating into profits
• Resource allocation: Focus investment on your most profitable activities
• Funding applications: Banks and investors use margins to assess business viability

What is a good profit margin?

A good profit margin depends on your industry and which margin type you measure. Here are typical benchmarks:

• Retail businesses: 2–5% net margin
• Professional services: 15–25% net margin

Your gross profit margin will naturally be higher than your net margin because it doesn't account for all costs. Operating and net profit margins give you the clearest picture of overall financial health.

Benefits of high profit margins for growth

High profit margins create growth opportunities by providing financial flexibility:

• Investment capacity: Provide more cash available to reinvest in business expansion
• Competitive advantage: Give room to adjust pricing strategies without losing profitability
• Investor appeal: Demonstrate efficient operations and strong management

High margins support growth but require strategic management to realise their potential. Yale Insights found that profit margins don't necessarily rise as businesses grow. Rapid expansion can temporarily reduce margins if short-term costs increase. Focus on sustainable growth and review your margins regularly to spot trends.

Factors affecting profit margins

Several factors can change your profit margins:

• Industry type: Consider that retail and hospitality businesses often have higher overheads and tighter margins than consultancies
• Economic conditions: Note that inflation and high interest rates increase costs. Business loans become more expensive when rates rise.
• Location: Factor in your rent and local taxes, which vary by area. Include these costs when you assess margins and set prices.

How to calculate profit margins

Profit margin formula: (Profit ÷ Revenue) × 100 = Profit Margin %

This percentage format makes it easy to:

• compare performance across different time periods
• benchmark against industry standards
• track improvement over time

Australian Accounting Standards require entities to present at least two profit or loss statements to support this kind of comparison.

Gross profit margin calculation

Let's say your business makes $20,000 by cleaning offices. It costs you $8,000 to provide those services, so your gross profit is $12,000.

$12,000 / $20,000 x 100 = 60% gross profit margin

Use the Xero gross profit margin calculator.

Net profit margin calculation

You also pay $4,000 in taxes, so your net profit is $8,000.

$8,000 / $20,000 x 100 = 40% net profit margin

Use the Xero net profit margin calculator.

Operating profit margin calculation

You spend another $3,000 on operating expenses, so your operating profit is $9,000.

$9,000 / $20,000 x 100 = 45% operating profit margin

How to increase your profit margins

Increase your profit margins by focusing on three main areas:

• Cost control: Reduce operational expenses without compromising quality
• Operational efficiency: Streamline processes to deliver more value with less resource
• Strategic pricing: Optimise prices to maximise revenue while remaining competitive

1. Control your costs

Reducing operational expenses improves your margins without changing your prices. Focus on:

• Subscriptions and services: Review recurring costs and cancel anything you no longer use
• Supplier costs: Negotiate better rates or find alternative suppliers
• Labour efficiency: Match staffing levels to demand and reduce overtime where possible

2. Make your operations more efficient

Streamlining operations helps you deliver more value with fewer resources. Consider:

• Customer service: Improve response times and service quality to increase repeat business
• Team innovation: Encourage staff to suggest process improvements
• Staff training: Train employees well so they work more accurately and efficiently
• Automation: Use software to handle repetitive tasks like invoicing and bank reconciliation

3. Adjust your pricing

A strong pricing strategy helps maximise revenue and boost your margins. Consider these approaches:

• Dynamic pricing: Adjust prices to match demand and seasonal changes
• Premium packages: Bundle products or services to increase average sale value
• Value-based pricing: Set prices based on the value customers receive, not just your costs
• Regular reviews: Check competitor pricing and adjust yours to stay competitive

Track your profit margins with Xero

Tracking profit margins regularly helps you spot trends and make confident decisions. With Xero accounting software, you can:

• view real-time profit and loss reports
• compare margins across different periods
• share insights with your accountant or bookkeeper

Review your business's performance to spot opportunities for improvement. Get one month free.

FAQs on profit margins

Common questions about profit margins answered.

What does a 20% profit margin mean for my business?

A 20% profit margin means you keep 20 cents as profit from every dollar of revenue after paying all expenses.

Is 80% profit margin realistic for small businesses?

An 80% gross profit margin is realistic for service or software businesses with low direct costs. An 80% net profit margin is achievable only when total expenses are extremely low, which is uncommon for most businesses.

Compare your margins to industry benchmarks for a more useful assessment.

How do profit margins vary between industries?

Profit margins vary significantly by industry:

• Retail: Expect lower margins due to high cost of goods (typically 2–5% net)
• Software and consulting: Expect higher margins due to lower direct costs (often 15–25% net)

A good margin in one industry might be low in another, so compare against your specific sector.

What's the difference between gross and net profit margin in simple terms?

Gross profit margin shows the profit you make just from selling your product or service, before considering your general business operating costs. Net profit margin shows your final profit after all expenses, including operating costs, interest, and taxes, have been deducted.

Net profit margin gives you the complete picture of your business's profitability.

How often should I calculate my profit margins?

Review your profit margins monthly. Regular tracking helps you spot trends, understand the impact of business decisions, and adjust pricing or costs quickly. Accounting software makes this a simple part of your monthly check-in.