Profit is the goal of any business, and profit margin ratios measure how well you're doing at reaching that goal. There are, however, a lot of terms thrown around when it comes to profit margins, and it can be confusing. Gross profit is one profit margin ratio -- but it's not the only one.

Profit Margins Defined

Profit is the money you have left over when you've paid all your expenses. Profit margins put that number into context by comparing dollars of profit to dollars of expense. To earn a higher profit, business owners can use these numbers to either adjust costs or boost prices. Profit margins are expressed as ratios like such as two-to-three, which means that for every $3 spent, the business earns $2 of profit. Profit margins may also be expressed as percentages, which can be helpful when you're comparing margins over time or across products. In this example, the profit margin would be 67 percent.

Gross Profit

Gross profit is the simplest of profit calculations. It is revenue minus cost of goods sold (COGS). Say you sell 40 widgets for $7.50 apiece, and each widget costs $4 to make. Your revenue is $300, or 40 multiplied by $7.50. Your COGS is $160, or 40 multiplied by $4. In this case, your gross profit is $300 minus $160, or $140. Turn this into a profit margin ratio by comparing your gross profit to your COGS: 140:160. Make it simpler by reducing the fraction to 7:8. Now you know that for every $8 you spend, you receive $7 of profit.

Uses of Gross Profit Margin

One benefit of knowing your gross profit margin is that it can help you set prices. You can decide what profit margin you want and work the equation backward to determine what your revenue -- and price -- should be. For example, suppose you want a $6 gross profit margin on a particular product, and it costs you $4 to make the product. You must sell it for $10 to realize the desired margin. Gross profit is also helpful when comparing different products or product lines to see which things bring in the most money for your business.

Additional Profit Margins

While very useful, gross profit margin is limited because it only accounts for the cost of the product you sell, not for any operating expenses or taxes. Business owners use several more margins to fully account for all costs. For example, to find out your operating margin, subtract the cost of administrating your office -- utilities, office supplies, worker's salaries and benefits, etc. -- from the gross profit. Subtract taxes from that number to get your net profit, or the proverbial bottom line. Where gross profit tells you if your products are priced correctly, operating and net profits monitor the health of your business as a whole.

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