Profit margin formula: gross, operating, net
There are three profit margins. Each tells you something different. Here's the formula for each, a worked example, and which one to focus on.
The three profit margin formulas
There are three profit margins every business owner should know. They use the same revenue figure but progressively subtract more costs.
1. Gross profit margin
Gross profit margin = (Revenue − COGS) ÷ Revenue × 100
COGS = cost of goods sold. The direct cost of making or buying what you sold. This tells you whether your unit economics work.
2. Operating profit margin
Operating profit margin = (Revenue − COGS − Operating expenses) ÷ Revenue × 100
Operating expenses = sales, marketing, R&D, G&A, rent, salaries. This tells you whether the business model works.
3. Net profit margin
Net profit margin = Net income ÷ Revenue × 100
Net income = revenue minus every cost, including taxes and interest. This tells you what's actually left for the owner.
A worked example
An ecommerce store generates $100,000 in monthly revenue. Their costs:
- COGS (product cost, packaging): $35,000
- Platform and payment fees: $5,000
- Shipping: $8,000
- Ad spend: $20,000
- Salaries and software: $15,000
- Rent and utilities: $3,000
- Interest on loan: $1,500
- Taxes: $2,500
Working through the three margins:
| Metric | Calculation | Result |
|---|---|---|
| Gross profit | $100,000 − $35,000 − $5,000 − $8,000 | $52,000 |
| Gross margin | $52,000 ÷ $100,000 | 52% |
| Operating profit | $52,000 − $20,000 − $15,000 − $3,000 | $14,000 |
| Operating margin | $14,000 ÷ $100,000 | 14% |
| Net profit | $14,000 − $1,500 − $2,500 | $10,000 |
| Net margin | $10,000 ÷ $100,000 | 10% |
A 52% gross margin sounds great. A 10% net margin is a more realistic read on the business — healthy for ecommerce, but a different number from the one your supplier-facing pricing might suggest.
The most common mistake
Founders quote gross margin to investors and bankers, expecting them to be impressed. The investor is mentally subtracting operating costs and asking about net. Always be clear which margin you're quoting.
What gets included in COGS
Industry conventions:
- Ecommerce/retail: Product cost, inbound shipping, packaging, payment processing fees. Not ad spend.
- Restaurants: Food cost, beverage cost, and sometimes direct kitchen labor. Not server wages or rent.
- SaaS: Hosting, third-party APIs, customer support, sometimes onboarding labor. Not sales/marketing or R&D.
- Services/consulting: Direct labor (consultant hours), subcontractors, project-specific travel. Not office rent.
If you're inconsistent about what goes into COGS, your margin numbers won't be comparable period-to-period.
Frequently asked
Which margin should I focus on?
All three, but for different purposes. Gross margin signals unit economics. Operating margin signals model viability. Net margin signals owner take-home. If you only watch one, watch operating margin — it's the most honest read on the business itself.
How do I increase profit margin?
Two levers: increase price, or decrease cost. Most businesses focus on cost (because it feels controllable), but price has 2-5x the impact on margin per percentage-point change. See our piece on how to price a product.
Is profit margin the same as ROI?
No. Profit margin measures profit as a percentage of revenue. ROI measures profit as a percentage of the investment that produced it. Two products can have the same margin but very different ROI if they require different capital to produce.