Profit margin is the percentage of revenue that’s left after costs. Gross profit margin looks at revenue minus direct costs (cost of goods sold). Net profit margin looks at revenue minus all costs including overheads, finance costs and tax. Markup is a related but different concept — markup is the percentage you add to cost to set price; margin is the percentage of price that’s profit. A 50% markup is a 33.3% margin, not a 50% margin. This calculator runs all four conversions: gross margin, net margin, markup-to-margin and margin-to-markup.
Gross profit margin vs net profit margin
Gross profit margin isolates the profit from your core trading activity, before overhead.
Gross profit margin = (Revenue − Cost of goods sold) / Revenue Ã, 100
A retailer who buys £40 of stock and sells it for £100 has gross profit of £60 and a gross margin of 60%.
Net profit margin is what’s left after all costs:
Net profit margin = (Revenue − All costs including overhead, interest, tax) / Revenue Ã, 100
The same retailer with £30,000 of annual overhead (rent, staff, utilities, marketing) on £200,000 of annual revenue and £80,000 of cost of goods sold has:
- Gross profit: £120,000 (60% margin)
- Operating profit (gross profit − overhead): £90,000 (45% margin)
- Net profit (operating profit − interest − tax): £67,500 if 25% combined finance and tax = 33.75% net margin
Each level tells you something different. Gross margin is about pricing power and cost discipline at the product level. Operating margin is about the efficiency of the overhead. Net margin is the bottom line.
Markup vs margin
The most common confusion in pricing is treating markup and margin as the same thing.
Markup is calculated on cost. Markup % = (Price − Cost) / Cost Ã, 100. Margin is calculated on price. Margin % = (Price − Cost) / Price Ã, 100.
So:
- £100 cost, £150 price: Markup = 50% (£50 / £100). Margin = 33.3% (£50 / £150).
- £100 cost, £200 price: Markup = 100% (£100 / £100). Margin = 50% (£100 / £200).
- £100 cost, £125 price: Markup = 25% (£25 / £100). Margin = 20% (£25 / £125).
The conversion formulas:
Margin = Markup / (1 + Markup)
Markup = Margin / (1 − Margin)
| Markup | Margin |
|---|---|
| 10% | 9.1% |
| 20% | 16.7% |
| 25% | 20% |
| 33% | 25% |
| 50% | 33.3% |
| 67% | 40% |
| 100% | 50% |
| 150% | 60% |
| 200% | 66.7% |
| 400% | 80% |
Why the confusion matters: a manager who tells the team “we need 50% margin on this product” while the team prices at “50% markup” gets 33.3% margin instead. On £1m of cost, that’s £170,000 of missed revenue.
What’s a “good” profit margin?
Industry varies enormously:
- Software / SaaS: gross margins commonly 70-85%, net margins 20-30% for established players.
- Professional services: gross margins 60-75%, net margins 10-20%.
- Manufacturing: gross margins 30-50%, net margins 5-15%.
- Retail (specialty): gross margins 40-60%, net margins 5-10%.
- Retail (food/grocery): gross margins 20-30%, net margins 1-3%.
- Restaurants and cafes: gross margins 60-70% (food cost roughly 30%), net margins 3-8% after high labour costs.
- Construction: gross margins 15-30%, net margins 2-8%.
Comparing your margins to industry averages is a useful sanity check, but more useful is comparing year-on-year for your own business. Margins drifting down typically means input costs are rising faster than prices, which has been the dominant story across most UK sectors since 2022.
A general rule of thumb: 5% net margin is poor, 10% is acceptable, 20% is strong. But this is sector-specific — a 5% net margin in food retail is industry-leading, while 20% in software is below average.
Pricing for a target margin
If you want a 40% margin on a product that costs £60 to produce:
Price = Cost / (1 − Target margin %)
Price = £60 / (1 − 0.4) = £60 / 0.6 = £100
Alternatively, work out the markup needed for the target margin:
Markup needed for 40% margin = 0.4 / (1 − 0.4) = 67%
So a £60 cost item priced with a 67% markup is £100, which is a 40% margin. Both routes give the same answer.
For service businesses, “cost” is typically your time at a defensible internal rate (your salary equivalent plus overhead), and the margin is the buffer between that internal rate and the day rate you charge clients.
Service business margins
Service businesses have a different shape:
- “Cost of goods sold” is largely your own time.
- Direct costs are tiny (software subscriptions, mileage, occasional materials).
- Gross margins look very high (often 90%+) but this hides the fact that your salary is the main “cost” and isn’t visible as such.
- Net margins, after recognising your salary as a cost, are usually 15-25% for a healthy services firm.
For a sole trader, the more useful margin is the implicit hourly rate after expenses divided by the chargeable rate. If you charge £600/day and after all expenses you take home £350/day, your effective margin is 58% — high by absolute standards but typical for service businesses.
Key takeaways
- Gross margin = profit on direct costs only. Net margin = profit after all costs including overhead, interest and tax.
- Markup is calculated on cost; margin is calculated on price. They are different numbers and confusing them costs money.
- A 50% markup is a 33.3% margin. Always confirm which one a price calculation is targeting.
- “Good” margin is sector-specific: 20% net is excellent in software, weak in food retail, market-leading in restaurants.
- Pricing for a target margin: Price = Cost / (1 − Target margin %).
Frequently asked questions
Why does my gross margin look fine but my business is unprofitable? Because gross margin only covers direct costs. Overhead — rent, salaries (other than yours, in a sole trader), insurance, marketing — sits below gross profit. A service business with high gross margin but high fixed overhead can still be unprofitable. Track operating margin (gross profit minus overhead) as the more honest middle measure.
Should I price by cost-plus or by value? Cost-plus pricing (cost + target margin) is the conservative method — guarantees a profit per unit but may leave money on the table where customers would pay more, and may miss bottom-of-market opportunities entirely. Value-based pricing (price based on customer’s willingness to pay) usually beats cost-plus in mature service businesses, but requires customer research and confidence to defend the higher price. Most businesses use a hybrid: cost as a floor, value as the ceiling, and competitive context to set within that range.
What’s a contribution margin? Contribution margin = Revenue minus Variable costs (everything that scales with volume). It’s the contribution each sale makes towards covering fixed overhead. Contribution margin is more useful than gross margin for breakeven analysis (see Breakeven) because it focuses on what changes with each additional sale.
Do margins include VAT? No. Margins are calculated on net (ex-VAT) revenue and net costs. VAT is a flow-through tax that shouldn’t affect your profitability calculation. Some retailers track “VAT-inclusive margin” for cash flow purposes, but the underlying business margin is always ex-VAT.