# Profit Margin: Definition, Types, Uses in Business and Investing

> **Definition**
>
> Profit margin is the percentage by which a company’s revenue exceeds its costs of operation.

## What Is a Profit Margin?

Profit margin is a common measure of the degree to which a company or a particular business activity makes money. Expressed as a percentage, it represents the portion of a company’s sales [revenue](https://www.investopedia.com/terms/r/revenue.asp) that it retains as a profit after subtracting all of its costs. For example, if a company reports a 35% profit margin during the last quarter, it means that it netted $0.35 from each dollar of sales generated.

### Key Takeaways

*   Expressed as a percentage, profit margin indicates how many cents of profit have been generated for each dollar of sales.
*   The most significant and commonly used profit margin is the net profit margin.
*   Profit margins are used by lenders, investors, and businesses to determine a company’s financial health, how well it's run, and its growth potential.
*   Profit margins typically vary by industry sector, and investors should be cautious in comparing the figures for different types of businesses.

![Profit Margin](https://www.investopedia.com/thmb/LC-uUPoO_J7CFtYSRbX8yCr-Jco=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/profitmargin-95e131f391884e60a86dd080c4f23dae.jpg)

*— Laura Porter / Investopedia*

## How Profit Margins Work

Businesses and individuals perform economic activities to make a [profit](https://www.investopedia.com/terms/p/profit.asp). Numbers like $X million in [gross sales](https://www.investopedia.com/terms/g/grosssales.asp) or $Y million in [earnings](https://www.investopedia.com/terms/e/earnings.asp) are useful but don’t address a business’s profitability and comparative performance.

Several quantitative measures are used to compute the gains (or losses) that a business generates, making it easier to assess its performance over different periods or compare it against competitors. [Profitability ratios](https://www.investopedia.com/terms/p/profitabilityratios.asp) are often the first thing investors look at before investing in a company and the most popular and widely watched of them all are profit margins.

A profit margin reflects the money a company retains as profit from its revenue. Put simply, it is the amount that a company earns relative to its revenue—usually expressed as a percentage. Revenue is the total amount of [income](https://www.investopedia.com/terms/i/income.asp) generated from its operations. This includes the income from sales. But, the company's costs need to be accounted for, so anything left once they are deducted from a company's revenue is profit.

While privately owned businesses may compute profit margins when they wish (weekly or monthly), [publicly traded companies](https://www.investopedia.com/terms/p/publiccompany.asp) must report them according to the standard reporting time frames, which are typically quarterly and annually. Businesses that operate on leverage may be required to compute and report their profit margins to [lenders](https://www.investopedia.com/terms/l/lender.asp) (like a bank) monthly.  

> **Important**
>
> There are other key profitability ratios that analysts and investors often use to determine the financial health of a company. They include return on assets (ROA) and return on equity (ROE).

## Types of Profit Margins

While net profit margin is the most familiar and commonly used measure, there are actually four levels or types of profit margin, based on four kinds of profit:

*   [Gross profit margin](https://www.investopedia.com/terms/g/gross_profit_margin.asp)
*   [Operating profit margin](https://www.investopedia.com/terms/o/operatingmargin.asp)
*   [Pretax profit margin](https://www.investopedia.com/terms/p/pretax-margin.asp)
*   [Net profit margin](https://www.investopedia.com/terms/n/net_margin.asp)

These profits are reflected on a company’s [income statement](https://www.investopedia.com/terms/i/incomestatement.asp) in the following sequence:

1.  A company reports its sales revenue and then accounts for the [direct costs](https://www.investopedia.com/terms/d/directcost.asp) of producing its products or services. What’s left is the [gross profit](https://www.investopedia.com/terms/g/grossprofit.asp).
2.  Then it accounts for indirect costs, like those associated with maintaining company headquarters, advertising, and [research and development (R&D)](https://www.investopedia.com/terms/r/randd.asp). What’s left is the [operating profit](https://www.investopedia.com/terms/o/operating_profit.asp).
3.  Next, it factors in interest on debt and adds or subtracts any unusual charges or inflows unrelated to the company’s main business. The result is its [pretax profit](https://www.investopedia.com/terms/p/profitbeforetax.asp).
4.  Finally, it accounts for taxes, leaving the net profit, also known as [net income](https://www.investopedia.com/terms/n/netincome.asp), which is the very bottom line.

> **Tip**
>
> Here are the mathematical formulas for calculating three types of profit margin: gross profit margin, operating profit margin, and net profit margin.

## Profit Margins in Business and Investing

### In Business

The profit margin is a widely used profitability measure by different businesses, whether they're billion-dollar enterprises or a hot dog stand on the sidewalk. It also indicates the profitability potential of larger [sectors](https://www.investopedia.com/terms/s/sector.asp) and overall national or regional markets. It is common to see headlines like “ABC Research warns on declining profit margins of American auto sector,” or “European corporate profit margins are breaking out.”

The profit margin has essentially become the globally adopted standard measure of the profit-generating capacity of a business and is considered a top-level indicator of its potential. It is one of the first few key figures to be quoted in the [quarterly results](https://www.investopedia.com/terms/e/earningsreport.asp) reports that companies issue.

Business owners, company management, and consultants use it internally to address operational issues and study seasonal patterns and corporate performance over time. A zero or negative profit margin translates to a struggling business that can't manage its expenses or fails to achieve good sales. Drilling it down further helps to identify the leaking areas—like high unsold [inventory](https://www.investopedia.com/terms/i/inventory.asp), excess or underutilized employees and resources, or high rentals—and then to devise appropriate action plans.

Enterprises operating multiple business divisions, product lines, stores, or facilities that are spread out geographically may use profit margins to assess the performance of each unit and compare them against one another.

> **Fast Fact**
>
> Profit margins serve many purposes. Among other things, they help companies to identify issues, raise funds, and attract investors.

### In Investing

Profit margins often come into play when a company seeks funding. Smaller businesses, like a local retail store, may need to provide it to get (or restructure) a loan from banks or other lenders.

Large corporations issuing debt to raise money must reveal how they intend to use the capital, which can provide insights to investors about the profit margin that might be achieved either by [cost cutting](https://www.investopedia.com/terms/c/cost-cutting.asp), increasing sales, or a combination of the two. The number has become an integral part of equity valuations in the [primary market](https://www.investopedia.com/terms/p/primarymarket.asp) for [initial public offerings (IPOs)](https://www.investopedia.com/terms/i/ipo.asp).

Profit margins are a significant consideration for [investors](https://www.investopedia.com/terms/i/investor.asp). When comparing two or more companies, investors often hone in on their respective profit margins. If a company has a higher profit margin than its peer group, it suggests it is better run and capable of generating greater returns for investors.

## Comparing Profit Margins

Profit margins are commonly used not just to compare a company's current performance against its past one but also to compare it to other companies. This only really works, though, when looking at similar companies operating in the same sector. What is an acceptable or good profit margin in one industry may be terrible or ridiculously high in another one.

Businesses like retail and transportation will usually have high [turnaround](https://www.investopedia.com/terms/t/turnaround.asp) and revenue, which can mean overall high profits but low profit margins. High-end luxury goods, by comparison, may have low sales volume, but high profits per unit sold.

Below is a comparison of the profit margins of four long-running and successful companies in the technology and retail spaces:

From 2015 to the first quarter of 2024, technology companies like Microsoft ([MSFT](https://www.investopedia.com/markets/quote?tvwidgetsymbol=MSFT)) and Alphabet ([GOOG](https://www.investopedia.com/markets/quote?tvwidgetsymbol=GOOG)/[GOOGL](https://www.investopedia.com/markets/quote?tvwidgetsymbol=GOOGL)) registered high double-digit quarterly profit margins compared to the single-digit margins achieved by Walmart ([WMT](https://www.investopedia.com/markets/quote?tvwidgetsymbol=WMT)) and Target ([TGT](https://www.investopedia.com/markets/quote?tvwidgetsymbol=TGT)). However, that does not mean Walmart and Target did not generate profits or were less successful at what they do compared to Microsoft and Alphabet. They just run very different businesses.

Since they belong to different [sectors](https://www.investopedia.com/terms/s/sector.asp), a blind comparison based solely on profit margins would be inappropriate. Profit margin comparisons between Microsoft and Alphabet, and between Walmart and Target, are more appropriate.

## Examples of Profit Margins

### High Profit Margin Industries

Producers of [luxury goods](https://www.investopedia.com/terms/l/luxury-item.asp) and high-end accessories can have a high profit potential despite low sales volume, compared with the makers of lower-end goods. A very costly item, like a high-end car, may not even be manufactured until the customer has ordered it, making it a low-expense process for the maker, without much operational overhead.

Software or gaming companies may make a substantial initial investment to develop a new software product or video game, but cash in big later by selling millions of copies with very little additional expense. Similarly, patent-secured businesses like pharmaceutical companies may incur high research costs initially but reap higher profit margins when they bring a new drug to market.

According to NYU Stern School of Business, the companies in the U.S. with the highest profit margins, as of January 2025, are software, retail REITs, and pharmaceutical companies.  

> **Warning**
>
> When comparing similar companies, be wary of unusually high profit margins. A closer investigation of the financials may reveal that the current margin was inflated by a one-off event and isn't sustainable.

### Low Profit Margin Industries

Operation-intensive businesses like transportation that may have to deal with fluctuating fuel prices, drivers’ perks and retention, and vehicle maintenance usually have lower profit margins. Agriculture-based ventures often also fall into this category owing to weather uncertainty, high inventory, operational overheads, the need for farming and storage space, and resource-intensive activities.

Automotive is another sector known for low profit margins. Automakers' profits and sales are limited by intense competition, uncertain consumer demand, and high operational expenses involved in developing dealership networks and [logistics](https://www.investopedia.com/terms/l/logistics.asp).

## How Do You Define Profit Margin?

Profit margin is a measure of how much money a company is making on its products or services after subtracting all of the direct and indirect costs involved. It is expressed as a percentage.

## What Are the Different Types of Profit Margins?

There are four ways of looking at a company’s profit margin: gross profit margin, operating profit margin, pretax profit margin, and net profit margin.

## What Is the Difference Between Gross Profit and Net Profit?

Gross profit measures a company’s total sales revenue minus the total cost of goods sold (or services performed). Net profit margin also subtracts other expenses, including overhead, debt repayment, and taxes. Net profit is considered a company’s [bottom line](https://www.investopedia.com/terms/b/bottomline.asp).

## The Bottom Line

There are many different metrics that analysts and investors can use to help them determine whether a company is financially sound. One of these is the profit margin, which measures the [company’s profit as a percentage of its sales](https://www.investopedia.com/ask/answers/010915/what-good-operating-margin-business.asp). In simple terms, a company’s profit margin is the total number of cents per dollar that a company receives from a sale that it can keep as a profit.

The most common and widely used type of profit margin is net profit margin, which accounts for all of a company’s costs, both direct and indirect.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. "[Exchange Act Reporting and Registration](https://www.sec.gov/education/smallbusiness/goingpublic/exchangeactreporting)."
>     
> 2.  NYU Stern. "[Margins by Sector (US)](https://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html)."