Profit margin is a managerial accounting tool that allows you to measure and compare your company's profitability against historical records and industry averages. Any increase in profit margin is an improvement in profitability. Ignorance of the factors that can help increase this margin serves as an obstacle toward maximizing profitability.

Definition and Formula

Profit margin expressed in percentage terms is the result of dividing net profit by net sales for a given period and multiplying the resulting figure by 100. The higher the difference between sales and expenses, including cost of goods sold, the higher the margin will be. Increasing the profit margin means adjusting these values to yield a bigger difference between expenses, including cost of goods sold, and sales.

Selling Price

Increasing your selling price without increasing total expenses and cost of goods sold will result to an increase in net profit and profit margin. As an example, a company with sales of $1,000, cost of goods sold of $700 and total expenses of $200 will have a profit of $100 ($1,000 - $700 - $200) and a profit margin of 10 percent ($100 divided by $1,000). A 10 percent increase in selling prices would increase sales from $1,000 to $1,100. The new profit would be $200 ($1,100 - $700 - $200). The profit margin would increase from 10 percent to 18.18 percent ($200 divided by $1,200).

Cost of Goods

Reducing the cost of goods sold without reducing your selling price and without increasing total expenses will result to a higher profit and a higher margin. Getting lower-priced suppliers, cheaper materials and using labor-saving technology are a few ways to reduce cost of goods sold. With the ratio of expenses to sales remaining constant, the bigger the difference between cost of goods sold and sales price, the bigger the profit margin will be.


Reducing expenses does not necessarily mean an increase in profit margin. Income statement values fluctuate, and understanding the effects of changes in amounts can be confusing, which is why relationships between accounts are better gauged using ratios. To increase profit margin, your expenses-to-sales ratio must decrease, while gross profit ratio must not. Dividing total expenses by total sales yields expenses-to-sales ratio, and decreasing expenses while keeping sales constant lowers this ratio. Dividing gross profit by sales yields gross profit ratio. Do not increase your cost of goods sold per unit or lower selling price to avoid decreasing the gross profit ratio.

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