Profit margin: definition, types and how to calculate

Published Friday 20 February 2026

Table of contents

• What is a profit margin?
• Types of profit margins
• How to calculate profit margins
• What is a good profit margin?
• Why do profit margins matter?
• How to increase your profit margins
• Use profit margin data to make better business decisions
• Track your profit margins with Xero
• FAQs on profit margin

Key takeaways

• Calculate all three profit margin types regularly to get a complete picture of your business health, as gross margin shows product profitability, operating margin reveals operational efficiency, and net margin indicates overall financial performance.
• Compare your margins against industry benchmarks rather than general averages, since what constitutes a good margin varies dramatically by sector—from 1-3% for grocery stores to 20-40% for software companies.
• Improve your margins by controlling costs through regular expense reviews, increasing operational efficiency with automation and staff training, and adjusting pricing strategies based on demand and competitor analysis.
• Use profit margin trends to guide key business decisions like pricing, budget allocation, and investment priorities, as rising margins indicate improving financial health while falling margins signal the need to review expenses or pricing strategies.

What is a profit margin?

Profit margin is the percentage of revenue your business keeps as profit after paying expenses. The higher your margin, the more money you retain from each sale.

A healthy profit margin signals your business is financially sound. Here's what it tells you:

• Revenue coverage: You're earning enough to pay your costs
• Performance insight: You can see which areas of your business are working
• Cost control: You can identify where to cut expenses

Profit margins vs net profit

Net profit is a dollar amount—the actual money left after all expenses. Profit margin is a percentage—showing what portion of each dollar you keep as profit.

For example, if you earn $100,000 and keep $10,000 after expenses, your net profit is $10,000 and your profit margin is 10%.

Profit margin vs markup

Profit margin and markup both measure profitability, but they calculate it differently:

• Markup is the percentage added to your cost to set a selling price
• Profit margin is the percentage of the selling price that becomes profit

Example: You buy a product for $60 and sell it for $100.

• Markup: ($100 − $60) ÷ $60 = 67% markup
• Profit margin: ($100 − $60) ÷ $100 = 40% margin

The same sale produces different percentages depending on which metric you use. Use markup when setting prices; use margin when measuring profitability.

Types of profit margins

There are three main types of profit margins:

• Gross profit margin measures the percentage of revenue remaining after subtracting the cost of goods sold. Use it to set pricing, spot inefficiencies, and compare performance across periods.
• Operating profit margin shows the percentage left after paying operating expenses like wages and materials, but before taxes and interest. Investors and lenders use it to assess how efficiently you run your core business.
• Net profit margin reveals the percentage of revenue remaining after all costs and taxes. It's the clearest indicator of your overall financial health because it accounts for every expense.

Learn more about net profit margin.

Each margin type serves a different purpose. Here's how they compare.

How the three margin types differ

Your three profit margins form a cascade, each one accounts for more expenses than the last:

Gross Margin

• Includes: Only cost of goods sold
• Excludes: Operating costs, taxes, interest

Operating Margin

• Includes: Cost of goods sold + operating expenses
• Excludes: Taxes, interest

Net Margin

• Includes: All costs and taxes
• Excludes: Nothing

Why they differ

Gross margin is always highest because it only subtracts direct product costs. Operating margin drops after accounting for rent, wages, and utilities. Net margin is lowest because it includes everything: taxes, interest, and all other expenses.

If your gross margin is healthy but your net margin is thin, your operating costs or taxes may be eating into profits.

How to calculate profit margins

To calculate any profit margin, use this formula:

Profit margin = (Profit ÷ Revenue) × 100

Expressing margins as percentages makes it easy to compare performance across different time periods or against other businesses, regardless of size.

Gross profit margin calculation

Here's how to calculate gross profit margin:

Example: Your cleaning business earns $20,000 in revenue. Your cost of goods sold is $8,000.

1. Calculate gross profit: $20,000 − $8,000 = $12,000
2. Divide by revenue: $12,000 ÷ $20,000 = 0.60
3. Multiply by 100: 0.60 × 100 = 60% gross profit margin

Try our gross profit margin calculator.

You can also calculate your operating profit margin using similar steps.

Operating profit margin calculation

From your $12,000 gross profit, you spend $3,000 on operating expenses like rent and utilities.

1. Calculate operating profit: $12,000 − $3,000 = $9,000
2. Divide by revenue: $9,000 ÷ $20,000 = 0.45
3. Multiply by 100: 0.45 × 100 = 45% operating profit margin

Finally, calculate your net profit margin to see your overall profitability.

Net profit margin calculation

Continuing the example above, you also pay $4,000 in taxes.

1. Calculate net profit: $12,000 − $4,000 = $8,000
2. Divide by revenue: $8,000 ÷ $20,000 = 0.40
3. Multiply by 100: 0.40 × 100 = 40% net profit margin

Try our net profit margin calculator.

What is a good profit margin?

A good profit margin varies by industry and margin type. As a general guide:

• 5% net margin: Low but acceptable for high-volume industries like grocery retail
• 10% net margin: While this is a common benchmark, the average net profit margin across all industries is closer to 8.54%.
• 20%+ net margin: Strong performance, common in consulting and software

Your gross margin will always be higher than your net margin because it doesn't include all expenses. Focus on net and operating margins for the clearest picture of financial health.

Industry benchmarks can help you understand where you stand.

Average profit margins by industry

Profit margins vary widely by industry. Here are typical net profit margin ranges:

• Grocery/supermarkets: 1–3%
• Restaurants: 3–9%. These margins vary by restaurant category, with quick-service spots often averaging 4–6% while full-service establishments average 2–4%.
• Retail (general): 2–5%
• Construction: 5–10%
• Professional services: 15–25%
• Software/tech: 20–40%
• Accounting/bookkeeping: 15–20%

These are averages; your specific margin depends on your business model, location, and efficiency. Compare your margins against businesses similar to yours rather than broad industry figures.

Why do profit margins matter?

Profit margins reveal your business's financial health by showing how much of your revenue you actually keep. Here's why they matter:

• Pricing decisions: Margins show whether your prices cover costs and leave room for profit
• Cost control: Tracking margins helps you spot rising expenses before they hurt your bottom line
• Funding access: Banks and investors review your margins when deciding whether to lend or invest

Healthy margins also create opportunities for business growth.

Benefits of high profit margins for growth

High profit margins typically mean a business:

• Attracts investment more easily: Financial health signals lower risk to lenders and investors
• Reinvests in growth: Extra profit funds expansion, hiring, or new equipment
• Innovates with flexibility: More margin creates room to test new pricing or products

Review your business's performance to find trends and opportunities. Benchmark your business against your competitors to see whether you're in a strong position. But margins aren't everything.

Do high profit margins guarantee growth?

No, high margins alone don't guarantee growth. Research from Yale Insights shows that profit margins don't necessarily rise as businesses expand; one study found that even during the early post-IPO years when growth is highest, firms didn't increase profit margins.

Rapid growth can actually shrink your margins if short-term costs spike. Sustainable growth matters more than fast growth. Always factor your margins into strategic decisions.

Several factors influence what margins you can achieve.

Factors affecting profit margins

Several factors influence your profit margins, some within your control, others not:

• Industry type affects margins because retail and hospitality typically have tighter margins than consulting or software businesses
• Economic conditions affect margins when inflation and interest rate changes increase costs, especially if you've borrowed to fund operations
• Location influences margins because rent and local taxes vary significantly and directly affect your overhead
• Business model determines margins because online businesses often achieve higher margins than brick-and-mortar stores due to lower overhead. For example, some retail sectors like the apparel industry can achieve a gross margin of over 51%, demonstrating how much models can vary.

How to increase your profit margins

You can improve your profit margins by reducing costs, increasing efficiency, and adjusting pricing. Here's how to approach each.

Control your costs

Review your expenses regularly to find savings:

• Cancel unused subscriptions and software licences
• Negotiate better rates with suppliers
• Reduce waste in materials or inventory; for example, using modern inventory tools can improve margins by 2–10% in the restaurant sector.
• Optimise staffing levels to match demand

Efficiency improvements also boost your margins.

Make your operations more efficient

Streamline operations to get more value from your resources:

• Automate repetitive tasks like invoicing and data entry
• Train staff to reduce errors and improve productivity, which also boosts retention. This is critical when the cost of turning one hourly employee in the restaurant industry is nearly $6,000.
• Improve customer service to boost retention and reduce acquisition costs
• Review workflows to eliminate bottlenecks

Pricing strategy is another lever for improving margins.

Adjust your pricing

A strong pricing strategy helps you capture more value from each sale:

• Adjust for demand: Raise prices during peak seasons or high-demand periods
• Bundle products: Combine items or services to increase average order value
• Add premium options: Offer higher-tier packages for customers willing to pay more
• Review regularly: Check competitor pricing and adjust to stay competitive

Use profit margin data to make better business decisions

Use your profit margin data to make smarter decisions:

• Set prices: Identify which products deliver healthy margins and adjust pricing accordingly
• Allocate budget: Direct resources towards higher-margin products or services for better returns
• Guide investments: Focus growth efforts on the most profitable parts of your business

Tracking changes over time provides additional insights.

What profit margin trends reveal

Profit margin trends show how your profitability changes over time. Here's what different patterns mean:

• Rising margins show your financial health is improving. You're either growing revenue or controlling costs effectively
• Falling margins indicate costs may be rising faster than revenue, signalling a need to review expenses or pricing
• Flat margins show your business is stable, but look for opportunities to improve

Compare your trends against industry benchmarks to see how you stack up against competitors.

Track your profit margins with Xero

Understanding your profit margins is just the first step; tracking them consistently is what drives results. Xero accounting software helps you:

• Monitor margins in real time with automated reporting
• Track revenue, expenses, and profitability from one dashboard
• Spot trends early so you can act before small issues become big problems

Ready to take control of your margins? Get one month free and see how Xero simplifies profit tracking for your business.

FAQs on profit margin

Here are answers to common questions about profit margins.

What does a 20% profit margin mean?

A 20% profit margin means you keep $0.20 as profit for every $1.00 in revenue. If your business earns $100,000, your profit is $20,000 after expenses.

What does a 30% profit margin mean?

A 30% profit margin means you retain $0.30 from every $1.00 in sales. This is considered strong for most industries and indicates healthy cost control.

What's the difference between profit margin and markup?

Profit margin measures profit as a percentage of the selling price. Markup measures profit as a percentage of the cost. The same transaction produces different percentages. A 50% markup equals roughly a 33% margin.

How often should I calculate my profit margins?

Review your profit margins monthly at minimum. Calculate them after each accounting period closes so you can spot trends and address issues quickly.

Can a business survive with low profit margins?

Yes, many successful businesses operate on thin margins by focusing on high volume. Grocery stores and discount retailers often run on 1–3% net margins. Success requires consistent sales volume and tight cost control.