What is profit margin?
Profit margin is profit expressed as a percentage of sales, showing how many pence of each pound of revenue a business keeps.
What profit margin means
A margin turns a profit figure into a percentage of revenue, which makes it easy to compare one year with another or one business with another of a different size. A 10% margin means the business keeps 10p of profit from every £1 of sales.
There are three margins in common use, each taken from a different line of the profit and loss account.
The three margins
- Gross margin: gross profit ÷ revenue. Shows the profit on what you sell before overheads.
- Operating margin: operating profit ÷ revenue. Shows profit after overheads, from running the business.
- Net margin: net profit ÷ revenue. Shows what is left after interest and tax.
Example
An events company has a year like this:
| Amount | Margin | |
|---|---|---|
| Revenue | £500,000 | |
| Direct costs (venues, catering, crew) | (£300,000) | |
| Gross profit | £200,000 | 40% |
| Overheads | (£140,000) | |
| Operating profit | £60,000 | 12% |
| Interest | (£4,000) | |
| Corporation Tax | (£11,090) | |
| Net profit | £44,910 | 9.0% |
Corporation Tax on £56,000 of profit is £14,000 at 25% less £2,910 of marginal relief, which comes to £11,090. The 40% gross margin is healthy, but overheads take most of it away. That points to running costs, not pricing, as the area to work on.
Why it matters for your business
Sales growth on its own can hide trouble. If margins are slipping, each extra sale earns less, and a business can get busier and poorer at the same time. Tracking margins monthly in your management accounts shows the effect of price rises, supplier increases and discounts as they happen.
Margin vs markup
Margin is profit as a share of the selling price. Markup is profit as a share of the cost. An item costing £60 sold for £100 has a 40% margin but a 66.7% markup. Mixing the two up is one of the most common pricing mistakes.
How to improve your margins
Small changes compound. A 3% price rise on a business with a 10% net margin, if customers stay, lifts profit by around 30%. Other levers include renegotiating supplier prices, cutting waste and returns, dropping low-margin products or clients, and controlling discounts. Look at margin by product or customer, not just the total, because a few unprofitable lines can hide behind good ones.
Common questions
It varies widely by sector. Many UK service businesses aim for net margins of 10% to 20%, while retailers and restaurants often run at 3% to 8% because their direct costs are higher. Compare yourself with similar businesses and, more importantly, with your own previous years.
Gross and operating margins are before tax. Net margin is usually after tax, although some people quote it before tax. Always make clear which you mean when comparing figures, especially with lenders, investors or a potential buyer of the business.