What is profitability? How to measure profit margins

Published Monday 30 March 2026

Table of contents

• What profitability means in small business
• Profitability metrics
• How to measure profitability
• Why measuring profitability matters
• Finding the numbers to measure profitability
• How to measure profitability with software
• How to manage profitability
• Common ways to improve profitability
• Track profitability with confidence using Xero
• FAQs on profitability

Key takeaways

• Calculate both gross profit margin (revenue minus direct costs) and net profit margin (revenue minus all costs) monthly to track your business's financial health and catch cost increases before they damage your bottom line.
• Set target margins based on industry benchmarks and take immediate action when margins fall below targets by raising prices, negotiating better supplier rates, or cutting unnecessary operating expenses.
• Use accounting software to automate profitability calculations and generate real-time profit and loss reports, eliminating manual spreadsheet errors and giving you instant visibility into margin trends.
• Focus on improving profitability through strategic pricing adjustments on high-demand products, upselling to existing customers, and eliminating low-margin offerings that drain resources without adding significant value.

What profitability means in small business

Profitability measures how effectively your business turns sales into profit. You express it as a percentage, showing how much revenue you keep after paying costs.

The main profitability metrics are gross profit margin and net profit margin. These ratios reveal what portion of each sale becomes actual profit.

Here's what your profitability levels might indicate:

• High profitability (healthy margins): You keep a large portion of revenue as profit. This is generally positive, though it may signal room to lower prices and boost sales volume.
• Low profitability (narrow margins): Most revenue goes toward expenses. While many consider a 10% net profit margin average, experts consider a 5% margin low according to profit margin benchmarks. This could mean costs are too high, pricing is too low, or you're in a price-competitive market.

Profit vs profitability: understanding the difference

Understanding the difference helps you make better decisions:

• Profit: The rand amount remaining after you pay all expenses
• Profitability: The percentage of revenue you keep as profit

High profitability only improves your bottom line when paired with strong sales. You need both good margins and good revenue to grow.

Understanding key profitability metrics helps you assess your business's financial performance.

Profitability metrics

Profitability metrics show what percentage of your revenue becomes profit. The most common are gross profit margin and net profit margin, sometimes called profitability ratios.

These metrics help you track financial health and compare performance over time.

The two most important metrics to understand are gross profit margin and net profit margin.

Gross profit margin

Gross profit margin measures the percentage of revenue remaining after paying direct costs, known as cost of goods sold (COGS). These include materials, labour, and other expenses that directly relate to delivering your product or service.

Why it matters:

• Shows production efficiency: Reveals how much you spend to create what you sell
• Funds operations: Gross profit covers rent, utilities, marketing, and admin costs
• Signals pricing health: Low margins may indicate pricing or cost issues, as a gross margin below 30% can signal financial strain for businesses with high gross costs, according to small business profit margin benchmarks

Net profit margin

Net profit margin measures the percentage of revenue remaining after paying all business costs, including operating expenses, interest, and overheads.

Why it matters:

• Shows overall profitability: Reveals your true bottom-line performance
• Guides reinvestment: Net profit funds growth or owner distributions
• Enables comparison: Helps benchmark against industry standards, as the average net profit margin by industry across all industries is around 8.5%

Note: You can quote net profit before or after taxes. This article focuses on pre-tax net profit.

Operating profit margin

Operating profit margin measures the percentage of revenue remaining after paying both direct costs and operating expenses, but before interest and taxes.

This metric shows how efficiently you run day-to-day operations. It's useful when comparing businesses with different financing structures, since it excludes interest costs.

To calculate: (Revenue − COGS − Operating expenses) ÷ Revenue × 100

How to measure profitability

To measure profitability, divide profit by revenue and then multiply by 100 to get a percentage. You'll need to figure out what your profit is first. This step differs between gross and net profit margin.

How to calculate gross profit margin

To calculate gross profit margin:

1. Subtract cost of goods sold (COGS) from revenue to get gross profit
2. Divide gross profit by revenue
3. Multiply by 100 to get the percentage

Try our gross margin calculator.

*Net profit can be quoted before or after taxes. If quoting after-tax net profit then you need to also subtract taxes.

How to calculate net profit margin

To calculate net profit margin:

1. Subtract all costs (COGS, operating expenses, interest, and overheads) from revenue to get net profit
2. Divide net profit by revenue
3. Multiply by 100 to get the percentage

Try our net profit margin calculator.

*Net profit can be quoted before or after taxes. If quoting after-tax net profit then you need to also subtract taxes.

Example of profitability calculation

A business takes R100K in sales, after spending R60K on inventory and R20K on general expenses. Here's how to calculate profitability step by step:

1. Calculate gross profit: R100K revenue − R60K COGS = R40K gross profit
2. Calculate gross profit margin: R40K ÷ R100K × 100 = 40%
3. Calculate net profit: R100K revenue − R80K total costs = R20K net profit
4. Calculate net profit margin: R20K ÷ R100K × 100 = 20%

In this example, the business keeps 40% of revenue after direct costs and 20% after all expenses.

Why measuring profitability matters

Regular profitability tracking helps you spot problems early and make informed decisions. Without it, you may not notice margin erosion until cash flow suffers.

Here's why ongoing measurement matters:

• Catches cost increases early: Materials, energy, transport, and rent prices shift regularly
• Supports pricing decisions: Helps you adjust prices before margins shrink too far
• Reduces stress: Clear visibility into margins helps you plan with confidence
• Balances value and profit: Ensures you're offering fair prices while staying profitable

Finding the numbers to measure profitability

You'll need specific figures from your financial records to calculate profitability. Here's where to find them:

• Revenue: Check your profit and loss statement (P&L) or sales reports
• Cost of goods sold (COGS): Find this on your P&L under direct costs or cost of sales
• Operating expenses: Your P&L lists operating expenses as overheads, admin costs, or general expenses
• Net profit: Your P&L shows net profit at the bottom after deducting all costs

If you use accounting software like Xero, these figures update automatically as you record transactions. You can pull a P&L report anytime to get the numbers you need.

Once you know where to find your numbers, software can streamline the calculation process.

How to measure profitability with software

Accounting software automates profitability calculations, saving you time and reducing errors. Instead of manual spreadsheets, you get real-time margin data at a glance.

With Xero, you can:

• View margins instantly: Open Xero analytics and select your reporting period
• Generate P&L reports: Pull profit and loss statements whenever you need them
• Track trends over time: Compare profitability across months or years

This approach gives you accurate, up-to-date figures without manual calculations.

How to manage profitability

Managing profitability means tracking your margins and taking action when they slip. Here's how to stay on top of it:

• Set a target margin: Ask your accountant or bookkeeper what's typical for your industry
• Review regularly: Check margins monthly, or whenever costs change significantly
• Watch for warning signs: Price wars, rising supplier costs, or declining sales all affect margins

If margins fall below your target, you have options:

• Raise prices: Adjust pricing to reflect your true costs
• Reduce COGS: Negotiate with suppliers or find more efficient production methods
• Cut overheads: Review general expenses for savings opportunities

For more strategies, see How to increase profits.

Common ways to improve profitability

Improving profitability means either increasing revenue, reducing costs, or both. Here are practical strategies that work for small businesses.

Increase revenue without adding costs:

• Raise prices on high-demand products or services
• Upsell or cross-sell to existing customers
• Focus marketing on your most profitable offerings

Reduce direct costs (COGS):

• Negotiate better rates with suppliers
• Find alternative materials or vendors
• Improve production efficiency to reduce waste

Lower operating expenses:

• Review subscriptions and recurring costs for savings
• Automate repetitive tasks to reduce labour costs
• Consolidate software tools where possible

Improve pricing strategy:

• Analyse which products or services deliver the best margins
• Phase out low-margin offerings that drain resources
• Test price increases on less price-sensitive customers

Small changes across multiple areas often add up to meaningful margin improvements. For example, some industries like apparel maintain high gross margins through a substantial markup on products, as shown in industry profit margin data.

Track profitability with confidence using Xero

Understanding your profitability helps you make smarter decisions about pricing, costs, and growth. Regular tracking keeps you in control of your margins and your business.

Xero makes profitability measurement simple:

• Automated calculations: See gross and net margins without manual spreadsheets
• Real-time reports: Pull P&L statements and analytics whenever you need them
• Clear dashboards: Track trends and spot changes at a glance

Take control of your profitability today. Get one month free and see how Xero simplifies your financial management.

FAQs on profitability

Here are answers to common questions about measuring and improving profitability.

What's a good profitability percentage for a small business?

Net profit margins typically range from 5% to 20% depending on your industry. Service businesses often see higher margins than retail or manufacturing; for example, average profit margin benchmarks show restaurants at around 11% net, while retail sits closer to 3%.

How often should I measure profitability?

Review your margins monthly at minimum, and check them whenever costs change significantly or you adjust pricing.

Can a business be profitable but still run out of cash?

Yes. Profitability measures earnings over time, while cash flow tracks actual money available. A profitable business can face cash shortages if customers pay slowly or large expenses come due. For example, retail businesses often have narrow margins and must cover expenses like rent, inventory, and payroll before receiving cash from sales, as explained in small business profit margin guidance.

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

Gross profit margin measures revenue minus direct costs only. Net profit margin measures revenue minus all costs, including overheads and operating expenses.

Do I need accounting software to measure profitability?

You can calculate margins manually using spreadsheets, but accounting software automates the process and reduces errors. It also gives you real-time visibility into your margins.