How to work out profit margin for your small business

All small businesses need to know how to calculate profit so they can work out how well they’re performing.

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While you may have started your business out of a passion for your niche, all small business owners need to make a profit to be successful.

But there are different terms to understand before you can calculate profit. Get started with this quick guide.

Why should you calculate profit?

Profit is one of the main indicators of business performance. With lots of money flowing in and out of your business it’s not always clear how much money you’re making. By calculating profit over a set period of time, you can keep an eye on your business’s health.

Imagine if you’re making lots of sales. You think you’re doing well but you’re actually struggling financially. When you work out your profit you see that you’re not being left with as much money as you’d like.

That might then lead you to look at improvements in other areas, like cutting transportation costs, making it more efficient.

It’s also useful to calculate profit if you have your eye on expanding your business. The healthier your profit, the more opportunity you should have to invest in growth.

And finally, in times of high inflation, it's important to get to grips with profit to understand how to tackle increasing costs.

The difference between gross profit and net profit

Before we show you how to calculate profit it’s important to understand the difference between net profit and gross profit. That’s because if you calculate one but think you’re calculating the other, you’ll get into trouble with your figures and won’t have an accurate picture of how your business is performing.

How to work out gross profit

Your gross profit is your total sales minus your direct costs. Direct costs are the costs of making your product or selling your service. These include the costs of your raw materials, transportation of those materials, and employees’ wages.

How to work out net profit

This is how much you’ve earned after you’ve subtracted your operating expenses from your profit, which include rent and business insurance (and sometimes your taxes too).

What is operating profit?

Operating profit is your income from sales after deducting operating expenses (such as rent, equipment, and employee payroll). It also excludes things like taxes, interest, and profit or loss from investments.

Similar to EBITDA, operating profit also takes into account non-cash expenses (depreciation and amortization).

Calculating operating profit can be a useful way to understand how efficient your business operations are before tax. It can also indicate whether you’ve got your pricing strategy right and how you're managing costs.

How to calculate operating profit

The operating profit formula is:

Gross profit minus operating expenses

Operating profit margin

You can also work out the operating profit ratio or margin as a percentage like this:

Operating profit margin = (operating profit ÷ revenue) x 100

Is there a formula to calculate profit?

Use the calculations below to work out both your gross profit and your net profit:

Gross profit = sales - direct cost of sales

Net profit = sales - (direct cost of sales + operating expenses)

What is profit margin?

Your profit margin is represented as a percentage rather than a figure in pounds. The profit margin essentially tells you the same thing as the calculations above, but the percentage is useful when comparing your performance to other businesses.

How to calculate profit margin

You can use these calculations to work out your gross profit margin and your net profit margin as a percentage:

Gross profit margin = (gross profit/ sales) x 100

Net profit margin = (net profit/ sales) x 100

Keep in mind that there isn’t necessarily a ‘good’ profit margin you should be aiming for. It depends on what your overall business objectives are.

Plus different businesses have different propositions which means comparing can be quite limiting. When setting profit goals, it’s good to look at similar businesses to yours.

You also need to consider your profit margin alongside other metrics like your cash flow and business turnover to get a full and accurate picture of your performance.

Profit margin calculator

You can use this online profit margin calculator from BKL accountants. You just need to input your total sales revenue and business operating costs and the tool will do the rest.

How to improve your profit margin

There are a number of ways to increase your profitability. The route you go down will depend on the specifics of your business but you could look at:

• reducing costs – many businesses choose to use this method. Are you on the best deals possible with the utility companies and your bank? When was the last time you negotiated rates with your suppliers?
• increasing turnover – one of the ways you can do this is by focusing on your existing customers and up-selling or cross-selling goods and services
• increasing productivity – are there any processes you know you can improve? Maybe using time and project management tools will boost your own (and your employees’) productivity, letting you get more done in a shorter space of time. Or you could look into lean manufacturing to make your processes more efficient

Read more about how to increase profit. Analysing your profit margin and drilling into other metrics should help you find more ways to improve.