What Is a Product's Profit Margin?
A product's profit margin tells you how much the product sells for above the actual cost of the product itself. Put another way, it reveals how much of the selling price is "markup." This invaluable metric determines which products in a company's line are bringing in the most revenue relative to their cost.
To calculate profit margin at the product level, start with the selling price of the item -- what you charge customers for it. Now subtract the cost of the product to you -- how much it cost you to obtain it or produce it. The resulting figure is your gross profit on the item. Divide the gross profit by the selling price, and the result is the product's gross profit margin, usually called just profit margin.
Profit margins are typically expressed as percentages. Say you own a shoe store, and you sell a particular pair of sneakers for $65. If those sneakers cost you $40 a pair to obtain, your gross profit on each pair is $25. Your profit margin is $25 divided by $65 -- 0.3846, or 38.46 percent. For each dollar in revenue you get for those shoes, you earn 38.46 cents in gross profit.
Where the profit-margin calculation gets tricky is in deciding what counts as a cost. In general, you include only the direct costs incurred in making or obtaining a product. For example, the cost of the sneakers would include the raw materials that went into them, the wages of the workers who put them together and the costs of running the machines used to make them. Other costs not directly associated with production -- salaries for managers, for example, or advertising or office supplies -- wouldn't be included. Similarly, if you sell shoes that you buy from a distributor, your cost would include the wholesale price, plus shipping and handling costs, but not other store overhead costs.
Gross profit margins can also be calculated company-wide. That calculation involves dividing the combined gross profit on all products by total sales revenue. The company-wide gross margin gives you a sense of how efficiently the company is running and how it stacks up against its competitors. And by comparing individual products' margins to the overall company figure, managers can also find their "winners" and "losers" -- items in their product line that are returning bigger or smaller profits than others. When speaking company-wide, the term "profit margin" by itself refers not to gross margins but rather to how much of each dollar in revenue remains as after-tax profit.