The success of your ecommerce store depends on various factors, with profit margin being a key one.
Understanding the impact of profit margin on your business allows you to optimize for long-term sustainability. It’s not just about boosting sales volume — it’s about making each sale count.
However, not all profits contribute to achieving your business goals. While some profits cover R&D or operational costs, others support expansion into new markets or product segments. Knowing which profit margin type to optimize is crucial.
With these distinctions in mind, let’s explore what profit margin is, why it matters, and how to enhance it to strengthen your business.
Profit margin is the percentage of your business’s income remaining after all costs are deducted. If you earned $20,000 in revenue this month and your total costs are $13,500, your profit is $6,500.
Typically, business profitability is calculated as the percentage of profit earned per dollar of sales. Divide your profit by your total sales and multiply by 100 to find your profit margin.
Example:
Profit margin = 6500/20000 x 100 = 32.5%
You earn 32.5 cents in profit for every dollar of sales.
Progress toward business goals can’t be measured by overall profit margin alone.
Here are the three types of profit margins and their respective formulas:
Gross profit margin
Gross profit margin measures profit after deducting costs directly related to producing products or services, known as Cost of Goods Sold (COGS).
Calculate gross profit margin as follows:
Gross profit margin = [(Revenue – COGS) / Revenue] x 100
For example, if an ecommerce store sells a product for $100 and it costs $60 to produce:
Revenue = $100
COGS = $60
Gross Profit Margin = ($100 – $60) / $100 x 100 = 40%
The company retains 40 cents as gross profit for every dollar of sales.
Operating profit margin
Operating profit margin includes all operating expenses, such as COGS, rent, utilities, and payroll.
Calculate operating profit margin as follows:
Operating Profit Margin = [(Revenue – COGS – Operating Expenses) / Revenue] x 100
Using the same example:
Revenue = $100
COGS = $60
Operating Expenses (e.g., website hosting, customer service, marketing) = $20
Operating Profit Margin = ($100 – $60 – $20) / $100 x 100 = 20%
This means the company retains 20 cents of every dollar in sales as an operating margin.
Net profit margin
Net profit margin is the most comprehensive profitability metric, accounting for all costs, including taxes and interest payments.
Here’s the net profit margin formula:
Net Profit Margin = [(Revenue – Total Expenses) / Revenue] x 100
Using the same example:
Revenue = $100
Total Expenses (COGS + Operating Expenses + Taxes + Interest) = $85
Net Profit Margin = ($100 – $85) / $100 x 100 = 15%
The company retains 15 cents of every dollar in sales as net profit margins.
It’s easy to confuse gross and net profit margins due to their similarities. However, there are significant differences.
Gross profit margins don’t consider operating expenses, taxes, or interest payments. Net profit does, making it the actual bottom line.
Gross profit margin helps you understand the core profitability of your products or services without considering sales expenses. Net profit shows the actual profit, allowing distribution to owners or reinvestment in the business.
Gross profit reflects the direct relationship between production costs and revenue. A high gross profit margin (over 50%) indicates efficient product or service delivery.
Net profit provides a complete picture. According to New York University’s benchmark reports, the retail industry’s average
