Understanding profit margins
Profit margin measures how much of your revenue you keep after expenses. It is one of the most important metrics for any business, telling you whether your pricing and cost structure are sustainable.
The three types of profit margin
- Gross profit margin: Revenue minus direct costs (cost of goods sold). For freelancers, this is revenue minus the direct costs of delivering the project (subcontractors, materials, licenses bought specifically for the project).
- Operating profit margin: Gross profit minus operating expenses (rent, software, marketing, insurance). This shows operating income from core business activities before taxes and interest.
- Net profit margin: Operating profit minus taxes and all other expenses. This is what you actually take home as the business owner.
Why margins matter more than revenue
A freelancer earning $200,000/year with 15% margins keeps $30,000. A freelancer earning $100,000/year with 40% margins keeps $40,000 while working less. Revenue is vanity. Profit is sanity.
According to Small Business Administration data, the median profit margin for professional services businesses is 15-20%. If yours is below 10%, your pricing or cost structure needs attention.
Margin vs markup explained
Margin and markup are related but different. Confusing them is one of the most common pricing mistakes.
The formulas
- Margin: (Revenue - Cost) ÷ Revenue × 100
- Markup: (Revenue - Cost) ÷ Cost × 100
Example
You sell a service for $100 that costs you $60 to deliver:
- Margin: ($100 - $60) ÷ $100 = 40%
- Markup: ($100 - $60) ÷ $60 = 66.7%
The conversion table
| Margin | Markup |
|---|---|
| 10% | 11.1% |
| 20% | 25% |
| 30% | 42.9% |
| 40% | 66.7% |
| 50% | 100% |
When to use each
Use margin when analyzing business performance and comparing to industry benchmarks. Use markup when setting prices based on your costs. If you want a 30% margin, apply a 42.9% markup to your costs.
Healthy profit margins by industry
Profit margins vary significantly by industry. What is healthy for a software business would be unsustainable for a restaurant. Here are benchmarks for service businesses based on data from NYU Stern School of Business and industry surveys.
| Industry | Typical net margin | Target for healthy business |
|---|---|---|
| Software/SaaS | 20-30% | 25%+ |
| Consulting | 15-25% | 20%+ |
| Marketing agencies | 10-20% | 15%+ |
| Design services | 15-25% | 20%+ |
| Web development | 15-30% | 20%+ |
| Content/Writing | 20-35% | 25%+ |
| Photography/Video | 10-25% | 15%+ |
What affects margins
- Pricing power: Specialists and experts command higher margins
- Overhead: Lower fixed costs mean higher margins
- Efficiency: Better systems and processes reduce cost per project
- Client mix: Enterprise clients typically allow higher margins than small businesses
How to improve your profit margins
There are only two ways to improve margins: increase revenue or decrease costs. Here are practical strategies for both.
Increase revenue (per project)
- Raise your rates: A 10% price increase with no change in costs goes straight to the bottom line. If you are fully booked, your rates are too low.
- Value-based pricing: Price based on outcomes, not time. A logo worth $50,000 to an enterprise should not be priced the same as one for a startup.
- Upsell related services: Add complementary offerings like maintenance, training, or ongoing support.
- Improve scoping: Underestimating projects is the fastest way to kill margins. Track actual vs estimated hours to improve future quotes.
Decrease costs
- Keep projects within scope: Clear contracts and change-order processes prevent un-billed work.
- Automate repetitive tasks: Templates, scripts, and workflows reduce time spent on non-billable work.
- Audit subscriptions: Most freelancers pay for software they rarely use. Cancel or downgrade unused tools.
- Outsource strategically: Delegate low-value tasks (bookkeeping, scheduling) so you can focus on high-margin client work.
Track per-project margins
Your overall margin is an average. Some projects are highly profitable, others barely break even. Track time and costs per project to identify which clients, project types, and services generate the best margins, then do more of those.
