In business, the true profit margin is the clearest measure of profitability at a given point in time. Profit margin is a revealing statistic because it shows the relationship between total revenue and total costs. As long as you know the total revenue and costs for a business, calculating the profit margin is relatively simple.
Calculate total revenue. Total revenue is simply the amount of money generated from sales. For example, if you set up a lemonade stand and sell 100 lemonades at $1 each, your total revenue is $100.
Subtract variable costs. Variable costs cover things such as the cost of materials, wages and shipping charges. Variable costs are so named because they change or vary with business activity. As demand pushes sales higher, you must buy more materials so that you can make more product to meet the demand. Therefore, the cost of materials is a variable cost.
Subtract fixed costs. Fixed costs cover things such as rent, interest on debt and salaries. These costs are known in advance and not subject to change in the same manner as variable costs.
Divide the net profit by the total revenue. Once you’ve subtracted fixed and variable costs, you have the net profit. Subtracting this number from total revenue gives the true profit margin. Going back to the lemonade stand example, if you have $30 in total costs, your profit margin is $70 / $100 or 70 percent.
Adam Parker is a writer from Virginia. He holds a Bachelor of Science from James Madison University. Parker has written articles for online sources including The Motley Fool, Gameworld Network and Glossy News.