What is profit margin?

Definition of profit margin

Profit margin, or margin for short, is a business’s profit divided by its sales. It shows how much profit a business is making for every pound of sales it earns.

Profit margin may be worked out using either the business’s gross profit (in which case it will be called the 'gross profit margin') or its net profit (or 'net profit margin').

Profit margin is expressed as a percentage.

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A business’s profit margin is usually considered in context, perhaps being compared with last year’s profit margin, the budgeted profit margin, or with competitors’ profit margins. This last one is called 'benchmarking'.

Example of profit margin:

A business made £10,000 of net profit in a year. Its sales for the same year were £70,000. Its profit margin is worked out as £10,000 / £70,000 = 14.29%.

Compared to the previous year’s profit margin of 13.24%, the business’s higher profit margin this year means that it's keeping more of every pound of sales it makes. This is usually good news.

Frequently Asked Questions

What might a falling profit margin mean?

A falling profit margin could indicate that your sales are lower but your costs have stayed the same, perhaps because you’ve lost a big customer. Or it could mean that your costs have increased, say if a supplier has put up his/her prices, and your sales haven’t increased as quickly.

Got questions? Ask Emily!

FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.

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