Profit margin is a fundamental financial metric that shows how effectively a business converts sales into actual profit. This crucial calculation shows what percentage of each revenue dollar remains as profit after accounting for various expenses.
In this guide, we’ll walk you through the profit margin formula, how to use Avada’s free Profit Margin Calculator, types of profit margins to track, and proven strategies to increase your profitability. Let’s get started!
What Is the Profit Margin Formula?
The profit margin formula measures how much profit a business makes for every dollar of sales. There are different types of profit margins (gross, operating, and net), but the most commonly used is net profit margin.
This calculation provides valuable insight into your company’s overall profitability and serves as a strategic guide for pricing decisions and long-term financial sustainability.
Profit Margin = (Gross Profit/Net Revenue) x 100
The formula helps businesses track financial health, compare performance across periods, and benchmark against competitors in their industry.
So, What Is a Good Profit Margin?
A good profit margin can vary depending on the industry. This is because different types of businesses have unique cost structures and pricing power. For example, it wouldn’t make sense to compare the profit margins of a retail store with those of an oil and gas company—they work in different conditions.
That said, there are some general benchmarks businesses can use to measure performance:
- Gross profit margin: 20% to 40% is usually considered strong
- Operating profit margin: 10% to 20% is often healthy
- Net profit margin: 5% to 10% is solid, while anything over 10% is excellent
From firsthand experience, these ranges help businesses quickly assess how efficiently they’re operating. For example, during my time working with small eCommerce brands, a net margin of just 7–8% was seen as a good sign, especially after accounting for ads, shipping, and overhead costs.
To back this up with data, a 2024 study by New York University’s Stern School of Business showed that net profit margins across various sectors ranged from 29% to 33%. For example, hotel and gaming businesses reported an average net margin of 10.08%, while money center banks reached as high as 30.89%.
How to Calculate Profit Margin Percentage by Avada Commerce
The Percentage Profit Margin Calculator by Avada Commerce helps you set the right price for your products by quickly determining the profit margin based on cost and markup percentage. Follow the steps below to get accurate results in seconds.
Step 1: Enter the Cost of the Item
- In the “Cost of item” field, input the total cost to produce or purchase your product.
- Ensure the value includes all relevant expenses, such as manufacturing, shipping, packaging, and labor.
Example: If it costs you $25 to make a product, enter “25”.
Step 2: Input the Markup Percentage
- In the “Markup percentage” field, enter the percentage you want to add to your cost to set the selling price.
- Markup is how much extra you charge beyond the cost to generate profit.
Example: If you apply a 60% markup, enter “60”.
Step 3: Click “Calculate Profit.”
After entering both values, click the “Calculate Profit” button. The calculator will display:
- Selling Price (based on your markup)
- Profit per unit
- Profit margin (%)
Here is the result with the input information:
Step 4 (Optional): Reset the Calculator
To try a new scenario, click the “Reset” button. This will clear your previous inputs so you can enter new values.
After knowing how to calculate profit margin formula, keep reading to follow the next section, “What categories are in the profit margins?”
Types of Profit Margins
Businesses use several types of profit margins to measure profitability at different operational levels. Each type provides unique insights into a company’s financial performance:
1. Gross Profit Margin
The gross profit margin calculator measures the percentage of revenue that exceeds the cost of goods sold (COGS). This metric focuses on production efficiency.
Formula: (Revenue – COGS) / Revenue × 100%
For example, if a company has $100,000 in revenue and $60,000 in COGS, the gross profit margin is 40%.
2. Operating Profit Margin
The operating profit margin reveals the percentage of revenue remaining after accounting for both COGS and operating expenses. This margin helps assess operational efficiency by showing how well a company manages its day-to-day expenses.
Formula: Operating Profit / Revenue × 100%
For example, the retail clothing store has:
- Revenue: $500,000
- Cost of Goods Sold: $300,000
- Operating Expenses (rent, salaries, utilities, etc.): $150,000
Calculation:
- Operating Profit = $500,000 – $300,000 – $150,000 = $50,000
- Operating Profit Margin = ($50,000 ÷ $500,000) × 100% = 10%
Interpretation: The company retains 10% of its revenue after paying for direct product costs and day-to-day operational expenses.
3. Net Profit Margin
The net profit margin calculator represents the percentage of revenue that remains as profit after all expenses, such as operating costs, taxes, and interest. It is the most comprehensive profitability metric, showing the company’s overall financial performance.
Formula: Net Profit / Revenue × 100%
Example: A software company analyzing one of its products:
- Price per unit: $200
- Variable costs per unit (customer service, hosting): $50
Calculation:
- Contribution Margin per Unit = $200 – $50 = $150
- Contribution Margin Ratio = ($150 ÷ $200) × 100% = 75%
Interpretation: Each unit sold contributes 75% of its revenue toward covering fixed costs and generating profit.
4. EBITDA Margin
The Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) margin focuses on operational performance without the influence of financial and accounting decisions.
Formula: EBITDA / Revenue × 100%
5. Contribution Margin
The contribution margin calculates the profitability of individual products after accounting for variable costs.
Formula: (Revenue – Variable Costs) / Revenue × 100%
Example: A software company analyzing one of its products:
- Price per unit: $200
- Variable costs per unit (customer service, hosting): $50
Calculation:
- Contribution Margin per Unit = $200 – $50 = $150
- Contribution Margin Ratio = ($150 ÷ $200) × 100% = 75%
Interpretation: Each unit sold contributes 75% of its revenue toward covering fixed costs and generating profit.
How to Improve Your Profit Margin
Improving your profit margin doesn’t always require raising prices. In fact, the most effective strategies often come from cutting unnecessary costs, increasing operational efficiency, and creating more value for your customers.
Here are practical ways to boost your profit margins:
1. Review Your Operating Costs Regularly
Start by identifying where your money goes. Audit your expenses monthly and cut back on subscriptions, tools, or services you no longer use. Even small savings add up over time.
2. Increase Average Order Value (AOV)
Encourage customers to spend more each time they buy. You can:
- Offer product bundles or volume discounts
- Set free shipping thresholds
- Use upsells and cross-sells at checkout
If you’re using Shopify, apps like Avada Boost Sales or Frequently Bought Together make this process easy and automated.
3. Improve Inventory Management
Efficient inventory management plays a crucial role in improving profit margins. Holding excess inventory can lock up valuable cash flow, increase storage and warehousing costs, and even lead to losses if products become obsolete, damaged, or expire. On the other hand, keeping too little stock may result in stockouts, missed sales opportunities, and dissatisfied customers.
To strike the right balance, businesses should adopt systems that offer real-time inventory tracking and demand forecasting. By syncing inventory across all sales channels and fulfillment centers, you can gain a clearer picture of what’s selling, where, and when. This allows you to restock popular items proactively while phasing out underperforming products. Additionally, integrating inventory data with analytics tools can help identify trends and optimize purchasing decisions based on actual customer behavior.
4. Automate Repetitive Tasks
Manual tasks can take up a lot of time and increase labor costs. Instead of handling these repetitive processes manually, businesses should explore automation to streamline operations. For example, you can automate email marketing campaigns, segment customers, and generate performance reports without manual input.
If you’re using Shopify, there are built-in tools like Shopify Flow that make it easy to create automated workflows without any coding. Additionally, third-party platforms such as Make.com help store owners handle more complex workflows across different apps. By automating these processes, you save time, reduce errors, and free up your team to focus on more important work.
5. Optimize Your Pricing Strategy
Make sure your prices reflect your value. Use competitor analysis and customer feedback to find a sweet spot between being competitive and profitable. Run limited-time offers or test dynamic pricing if applicable.
6. Focus on Retention, Not Just Acquisition
Keeping existing customers is much cheaper than acquiring new ones. Launch loyalty programs, send personalized offers, and follow up with post-purchase emails. Shopify-compatible tools like Joy: Loyalty & Rewards can help build long-term customer relationships.
See more:
Bottom Line
Profit margin is more than just a number—it’s a clear reflection of how efficiently your business operates. By using tools like the Avada Profit Margin Calculator, you can make informed pricing decisions and stay competitive in your market. Whether you’re running a Shopify store or scaling a larger operation, regularly reviewing and refining your profit margin ensures your business remains healthy, resilient, and ready for growth.