Types of Profit Margins
There are three different types of profit margins: gross profit margins, operating profit margins, and net profit margins. Each one provides you with a peek at how efficiently a company is operating.
Gross Profit Margin
Gross profit is the simplest profitability metric because it defines profit as all income that remains after accounting for the cost of goods sold (COGS). COGS includes only those expenses directly associated with the production or manufacture of items for sale, including raw materials and the wages for labor required to make or assemble goods. The gross profit margin compares gross profit to total revenue, reflecting the percentage of each revenue dollar that is retained as profit after paying for the cost of production.
The formula for gross profit margin is:
GPM= Net Sales−COGS / Net Sales ×100
What Is a Good Profit Margin?
That depends on the company and the industry. That's because profit margins vary from industry to industry, which means that companies in different sectors aren't necessarily comparable. So a retail company's profit margins shouldn't be compared to those of an oil and gas company.
Having said that, you can use a scale of how a business is doing based on its profit margin. A profit margin of 20% indicates a company is profitable while a margin of 10% is said to be average. It may indicate a problem if a company has a profit margin of 5% or under.
There are some studies that analyze profit margins by industry. New York University analyzed a variety of industries with net profit margins ranging anywhere from about -29% to as high as 33%. For instance, the study showed that the hotel/gaming sector had an average net profit margin of -28.56% while banks in the money center had an average net profit margin of 32.61%.
Regardless of where the company sits, it's important for business owners to review their competition as well as their own annual profit margins to ensure they're on solid ground.