Profit Analytics Blog
Read expert articles with insights about e-commerce profitability from analyzing thousands of e-commerce businesses' data.
Net, Gross, & Operating Profit Margins: What Is High?
Two popular metrics commonly used to gauge the success of a business are profit margin and net profit. And, while net profit is great at reflecting how much profit is generated from revenue, for some applications, it’s arguable that a business’ profit margin is a more valuable metric. This is because profit margin allows you to gauge how efficiently your business is running overall.
To help you better understand these two metrics and break down everything involving income, revenue, and profit, take a moment to read through this post.
Difference Between Net, Gross, & Operating Profit Margins
Net profit margin, gross profit margin, and operating profit margin are three metrics commonly used to analyze and measure the income of a business. To help you better understand the differences between these three metrics, here’s a quick definition and demonstration of how each is calculated:
Net Profit Margin
Net profit margin is a measure of profitability. It is calculated by determining a business’s net profit as a percentage of revenue.
The net profit margin formula looks like this:
[(revenue-cost)/revenue] x 100
A net profit margin is used to evaluate a business’s relative performance. For example, a business may have a net profit margin of 27% while a competitor has a net profit margin of 45%. This means that the competitor's business has a higher margin and is more profitable. Another reason to compare one business’s net profit margin against another’s (or against the industry average) is to determine which business to invest in.
Another way to look at net profit margin is by using a net profit margin ratio.
The net profit margin ratio is just another way to measure a company's profitability. It is calculated by dividing net income by revenue. This ratio tells you how much profit a company makes on each dollar of sales. Simply put, a high net profit margin ratio means that the company is making a lot of money on its sales. While a low net profit margin ratio means that the company is not making as much money on its sales.
Gross Profit Margin
The gross profit margin differs from the gross profit and is expressed as a percentage. It is calculated by determining the difference between revenue and the cost of goods sold (COGS), divided by the revenue.
The gross profit margin formula looks like this:
[(revenue-COGS)/revenue] x 100
Gross profit margin is the percentage of revenue that remains after paying for COGS. This calculation is useful because it measures the efficiency of the business' operations. It also provides a benchmark for measuring other business expenses. For example, if you find your gross profit margin is low, you can look into reducing COGS, such as reducing shipping costs or cutting out unnecessary expenses like excess staff or unneeded operation costs.
Need help managing your expenses? Read Keeping Track of Your E-Commerce Business Expenses or How to Calculate COGS for Your Shopify Store.
Operating Profit Margin
Operating profit margin is the ratio of operating income to net sales. This is usually expressed as a percentage and is also commonly called return on sales.
The operating profit margin formula looks like this:
(operating profit/net sales) x 100
The operating profit margin ratio is used to determine how well a company can cover its operating costs with revenues. The operating profit margin shows how effective a company is at generating profits from its sales, which is a useful performance indicator for comparing the operating efficiency of similar companies.
Benefits of Knowing Your Profit Margins
The ultimate goal for a business is profitability.
If your sales are up, but your margins are down, you may need to take a deeper look at how you are running your business. As important as it is to price your products and services fairly, it’s also essential not to undercut yourself and leave your business open to becoming unprofitable. That’s why knowing your profit margin is important because it shows how much of every dollar is flowing to your bottom line.
A business with a good profit margin is able to remain afloat during tough times and capitalize on opportunities when they arise, such as seasonal strategies for boosting sales. A high profit margin means that the company is making enough money on each sale to cover its costs and generate a desirable return on investment. This allows the business to reinvest in itself, expand its operations, and pay its employees competitive wages.
A high profit margin also sends a positive signal to potential investors, lending credibility and stability to the business. Ultimately, a good profit margin is essential for maximizing company growth and achieving long-term success.
Limitations of Profit Margin Calculations
In order to calculate a company's profit margin, business owners must first know their total revenue and total expenses. However, not all expenses are equal when it comes to determining a company's profit margin. For example, research and development costs are typically expensed in the year they are incurred, while depreciation expenses are spread out over the life of the asset. This can lead to inaccurate calculations of a company's profit margin if these costs are not accounted for correctly.
Another limitation of calculating profit margins is that they do not take into account changes in sales volume. For example, if a company doubles its sales volume but keeps its costs constant, its profit margin will stay the same. Conversely, if a company experiences a decrease in sales volume but keeps its costs constant, its profit margin will increase.
Finally, it should be noted that calculating profit margins is not an exact science. The outputs, while helpful, should be considered an estimation. If you need help calculating your profit, read Mistakes to Avoid When Calculating Profit for Your Shopify Store.
What Is a High Profit Margin?
What is considered a good profit margin will vary depending on which industry or niche your business falls within. Although, as a general rule of thumb, the sustainability of different gross profit margin ranges is commonly understood as the following:
5-10%: Low and unsustainable20-25%: Average30-35%: Good and more sustainable for a business>35%: Fantastic
Like gross profit margins, the higher the operating profit margin, the more sustainable a business is overall. For most industries, a 15% operating profit margin is considered good as it means that each dollar earned in revenue brings in 15 cents of profit.
Good Profit Margins by Industry
Each industry considers different percentages of profit margin to be either good or bad. If you're wanting to know what a good profit margin is for products in e-commerce, retail, and more, here’s an industry-specific look:
Retail: 20-45%E-commerce: 15-20%Clothing: 4-13%Wholesale: 15-20%Hospitality: 10-15%Consulting: 80-100%Software: 70-85%
In a nutshell, net profit margin, gross profit margin, and operating profit margin are all ways of measuring a business’s income. The terms are sometimes used interchangeably, but it's important to understand that there are differences between them. Additionally, what is considered a good profit margin for clothing might not be the same for wholesale foods, so understanding the difference can help you plan for your chosen industry better. The bottom line is that these three metrics inform us about the income and financial health of a business.