Incremental Margin: All You Must Know About [Tool Suggested]

To better understand your profitability and growth, you should calculate your incremental margin to see all the ups and downs with your profitability metrics. 

In this guide, we’ll help you have a better understanding of what incremental margin is, its formula, an example, and a suggested tool to track your profit margins incrementally.

What is the Incremental Margin? 

Incremental margin reflects the change in a profit metric per unit change in revenue. In other words, this metric assesses the impact of changes in sales volume on your profits.

By assisting you in analyzing financial data and forecasting the future performance of your company, this metric directly contributes to the growth of your business.

Below is the chart that illustrates the incremental EBIT margin of Wayfair – A global brand for online home furniture, between 2014 and 2016.

If you are a Shopify store owner, you can use TrueProfit to see your real-time incremental profit margins by day, week, month, quarter and year. After installing the app, go to “P&L Report” and select the date range you want to see your incremental profit margins.

Incremental Margin Formula

Below is the incremental margin formula for your calculation:

Incremental Margin = (Ending Profit Metric – Beginning Profit Metric) / (Ending Revenue – Beginning Revenue)

The incremental margin can be presented as a percentage. As mentioned above, it determines how a particular profit metric has changed based on any changes in revenue. 

So, depending on the data you want to evaluate, you may customize the calculation (i.e. incremental contribution margin, incremental net profit margin). Note that the increments for various metrics will vary.

Five Profitability Metrics to Calculate Incrementally 

Your business’ profit margin is the proportion of net revenue that is left over after specific costs have been subtracted. Most of them are a ratio of profitability metric to revenue.

While profit margins on their own are quite informative, another method of analyzing them is calculating the incremental margin, which demonstrates how profit margins are changing in response to changes in sales.

For a better analysis of your business’ financial health, here are the 5 profitability metrics you should calculate incrementally.

#1. Gross Profit Margin

The gross profit margin reveals your profit after deducting the cost of goods sold (COGS). This refers to the direct expenses incurred during the production of your goods or services.

Here is the formula to calculate your gross profit margin:

Gross Profit Margin = (Gross profit / Revenue) x 100%

Gross profit margin sheds light on the profitability of your company and offers insight into how these expenses are managed because it considers direct expense. A low gross profit margin could be a sign that your COGS is too high or your product pricing is too low.

Gross profit is a simple figure as it includes only COGS. However, the next 4 metrics are rather complicated as each takes different costs into account. Hence, you should have a look at our table below to get brief and basic information to easily catch up with us.

#2. Net Profit Margin

Your net profit margin takes into account all of your costs. By subtracting COGS, interest, taxes, operations, and other costs from your revenue, you have net profit. Divide the net profit by total revenue and multiply by 100%, and you’ll have your net profit margin.

Net Profit Margin = (Net Profit / Revenue) x 100%

By factoring in many different costs, it offers you a clearer and more comprehensive picture of your business. Without a doubt, the most significant profitability analysis calculation is the net profit margin.

In the end, it determines whether your existing strategies are effective by examining if you are turning a sufficient profit while keeping your costs in check. 

#3. Operating Profit Margin

Your operating profit margin provides information on the percentage of sales profits your company makes after paying for production but before deducting interest and taxes.

Operating Profit Margin = (Operating profit / Revenue) x 100%

Operating profit margin measures how well you manage your sales, or, more specifically, whether you can generate profits from only your core business’s functions. 

A low operating profit margin suggests that rather than from the good or service you’re offering, the majority of your income comes from some other places.

#4. EBIT Margin

The EBIT margin is a financial ratio that assesses your company’s profitability without accounting for the impact of taxes and interest. 

EBIT Margin = (EBIT / Revenue) x 100%

Low EBIT margins represent low business profitability. Investors can decide whether your low EBIT margin results from the competitive environment, where all companies have lower margins, or a problem that only exists within your company, where it is experiencing lower revenues and more costs.

#5. EBITDA Margin

How much money your company makes before interest, taxes, depreciation, and amortization is measured by EBITDA margin. 

Here is the formula to calculate your EBITDA margin:

EBITDA Margin = (EBITDA / Revenue) x 100%

In particular, as non-cash expenses are not taken into account in the calculation, it will show whether your company has a good cash flow.

A Hypothetical Example of Incremental Margin Calculation

Let’s assume that you are in charge of calculating your company’s incremental margin from 2020 to 2021. 

The financial figures and related profit margins of your business are displayed in the table below.

Financial Assumptions Of ABC Inc.
	2021	2022
Revenue	$1,000,000	$1,200,000
COGS	$600,000	$720,000
Gross Profit	$400,000	$480,000
Operating Expenses	$200,000	$240,000
Operating Profit	$200,000	$240,000
Non-Operating Expenses	$20,000	$30,000
EBIT	$180,000	$210,000
Depreciation and Amortization	$50,000	$60,000
EBITDA	$230,000	$270,000
Interest Expenses	$30,000	$40,000
Net Profit	$100,000	$110,000

Now you can apply the incremental margin formula for each of the profit metrics to find out the incremental margins in the period of 2 years, 2021 – 2022.

1. Incremental Gross profit margin = ($480,000 – $400,000) / ($1,200,000 – $1,000,000) = 40%
2. Incremental Net Profit Margin = ($110,000 – $100,000) / ($1,200,000 – $1,000,000) = 5% 
3. Incremental Operating profit margin = ($240,000 – $200,000) / ($1,200,000 – $1,000,000) = 20%
4. Incremental EBIT Margin = ($210,000 – $180,000) / ($1,200,000 – $1,000,000) = 15% 
5. Incremental EBITDA margin = ($270,000 – $230,000) / ($1,200,000 – $1,000,000) = 20% 

Frequently Asked Questions

• What is the concept of margin and increment?

Margin is the profit you generate from selling your goods or services, which provides you with the understanding of the overall financial health of your company.

Increment is the amount or degree of positive or negative change in the value of one or more of variables within a collection.

• What is incremental profit or loss?

Incremental profit is the profit increase or decrease resulting from a particular managerial decision. Total profit increases as long as incremental profit is positive. When incremental profit is negative, total profit declines.

Incremental loss is defined as losses that result from, are caused by, are connected to, or are attributable to the structure change.

• What is net incremental profit?

Net incremental profit is the profit your company makes as a result of an increase in sales over a specific time period.

• How do you calculate with the incremental formula?

To figure out your incremental margin, use the following formula:

Incremental Margin = (Ending Profit Metric – Beginning Profit Metric) / (Ending Revenue – Beginning Revenue)

Wrapping up!

Now that you have learned everything about incremental margin and its formula, you can apply it to your business’ financial analysis to get a better grasp of your profitability.

However, calculating your profit margins incrementally can be a tiresome process if you do it manually using spreadsheets. Because you will then have to keep pace with the constant-shifting data from different sources. So if you have a Shopify store and want to see all your key metrics over time, install TrueProfit so you can always know the trends and fluctuations of your profits and losses.

Discover what proper profit-tracking looks like at trueprofit.io