Profitability: profit margins

The three margins

• Gross profit margin = gross profit / revenue x 100
• Operating profit margin = operating profit / revenue x 100
• Profit for the year (net profit) margin = profit for the year / revenue x 100

Each shows how many cents of profit are made from every dollar of sales at that level.

Margins for the invented company in the previous lesson

Interpreting margins

• A higher margin is generally better, but compare like with like: supermarkets run on low margins with high volume; luxury brands have high margins and lower volume.
• A falling gross margin: rising supplier or material costs not passed on in prices, or price cuts to win sales.
• A gap widening between gross and operating margin: overheads growing faster than sales.
• Compare over time and with competitors; a single year's figure means little alone.

Improving profitability

To raise margins, the business must earn more profit from each dollar of revenue:

• Raise prices (if demand is inelastic or the brand is strong).
• Cut the cost of sales: negotiate with suppliers, reduce waste, improve productivity.
• Cut overheads: move to cheaper premises, use technology, reduce management layers.
• Change the product mix towards higher-margin products.

Note that selling more at the same price and unit cost raises gross profit but leaves the gross margin unchanged; the operating margin rises only because fixed overheads are spread over more revenue.

Worked example

Revenue falls from $2.0m to $1.8m while gross profit falls from $800,000 to $630,000. Compare the gross profit margins.

1. Last year: 800,000 / 2,000,000 x 100 = 40%
2. This year: 630,000 / 1,800,000 x 100 = 35%
3. The margin has fallen by 5 percentage points: each dollar of sales earns less gross profit, perhaps because supplier costs rose or prices were cut.

Answer: Down from 40% to 35%

Check yourself

1. Revenue is $640,000 and gross profit is $256,000. Calculate the gross profit margin.
   Show answer

   40 %. 256,000 / 640,000 x 100 = 40%.

2. Revenue is $1,250,000 and operating profit is $87,500. Calculate the operating profit margin.
   Show answer

   7 %. 87,500 / 1,250,000 x 100 = 7%.

3. Revenue is $380,000 and profit for the year is $22,800. Calculate the profit for the year margin.
   Show answer

   6 %. 22,800 / 380,000 x 100 = 6%.

4. A business has a gross profit margin of 35% and gross profit of $490,000. Calculate its revenue.
   Show answer

   $1400000. Revenue = 490,000 / 0.35 = $1,400,000.

5. Revenue $720,000; cost of sales $468,000; operating expenses $180,000. Calculate the operating profit margin to 1 decimal place.
   Show answer

   10.0 %. Operating profit = 720,000 - 468,000 - 180,000 = 72,000; 72,000 / 720,000 x 100 = 10.0%.

6. A firm's gross margin falls from 42% to 38.5%. By how many percentage points has it fallen?
   Show answer

   3.5 percentage points. 42 - 38.5 = 3.5 percentage points.

7. A café's gross profit margin falls while its prices are unchanged. The most likely cause is
   • rent has increased
   • the cost of ingredients has risen
   • the loan interest rate has risen
   • sales volume has increased
   Show answer

   the cost of ingredients has risen. Gross margin depends on price and cost of sales.

8. A firm doubles its sales volume at the same price and the same cost per unit, with no change in overheads. Its operating profit margin will
   • rise
   • fall
   • stay the same
   • become negative
   Show answer

   rise. Fixed overheads are spread over more revenue, so operating profit rises faster than revenue.

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Sources

• Pearson Edexcel International Advanced Subsidiary/Advanced Level in Business specification (2018)

Last updated 8 November 2026. Spotted a mistake? Tell us.