Profit margins measure how efficiently a business converts revenue into profit. There are three key margins: gross margin focuses on production efficiency by comparing revenue to COGS, operating margin adds administrative and selling expenses into the picture, and net margin shows the bottom line after all expenses including taxes.

The formulas are: Gross Margin = (Revenue - COGS) / Revenue, Operating Margin = (Revenue - COGS - Operating Expenses) / Revenue, and Net Margin = (Revenue - COGS - Operating Expenses - Taxes) / Revenue. Each level tells you something different about where money is being spent and how much profit remains.

For example, a company with $500,000 in revenue, $200,000 in COGS, $150,000 in operating expenses, and $30,000 in taxes has a gross margin of 60%, an operating margin of 30%, and a net margin of 24%. Comparing these margins over time and against industry benchmarks helps identify areas for improvement and gauge overall business health.