Running A Business

Is Your Small Business Profit Margin Good?

Apr 06, 2022 • 8 min read
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      Quick—when was the last time you calculated your business’s profit margin?

      If you answered “Last week,” excellent! And if you don’t remember, you’re probably way overdue.

      But were your numbers good or bad? Every company is unique, so the yardstick you measure your profit margins against isn’t the same one your neighbor uses. What’s considered a “good” range varies across industries—restaurants average a slim 6–8%, whereas the advertising and public relations industry averages a more generous 11–20%.

      That means your answer should probably be, “It depends.” Here’s why.

      What Are Profit Margins?

      Profit margins are key performance indicators that can help you make strategic decisions to keep your business profitable and healthy.

      Your small business’s profit margin can help you make strategic decision that keep your business profitable and healthy.

      To go deeper, we cover various different profitability ratios here, including how to calculate them and what their purpose is. The 3 most commonly used are:

      • Net: essentially shows a company’s bottom line
      • Gross: can indicate how well strategies like a price increase are working
      • Operating: can show out-of-control expenses

      So what’s the difference between a profit number and a profit margin? Profit numbers show a dollar amount—e.g., a $5 profit on an item sold. Profit margins are a percentage that allows your number to be compared against industry averages and competitors or to reveal trends within your own business.

      For example, imagine a bakery wants to know if 2 desserts are equally profitable. The calculations for this example are:

      • Gross profit = net sales – cost of goods sold (COGS)
      • Gross profit margin = (gross profit / net sales) * 100
      Vanilla CakeKey Lime Pie
      Net Sales$10$20
      COGS$5$15
      Gross Profit$5$5
      Gross Profit Margin50%25%

      Both desserts generate a $5 gross profit per unit. However, vanilla cake has a much higher gross profit margin. That kind of insight might influence whether pie stays on the menu or suggest that social media promotions should market the cake.

      What Should Your Profit Margin Be?

      Once you’ve calculated your profit margin, how do you know if it’s good or bad? In other words, what should your profit margin be? The answer is—it depends.

      According to the Corporate Finance Institute, the average net profit for small businesses is 10%, while 20% is considered good. But your mileage may vary depending on a variety of factors.

      For example, a company’s size and life stage can heavily influence profit margins. It wouldn’t be reasonable to expect a mom-and-pop retail store to have the same profit margin as a monster retailer like Walmart. Big companies have more leeway for spreading out or reducing costs through automation than small businesses.

      Seasonality can significantly alter your margins, too. No one would expect a ski resort’s summertime profitability margins to resemble the values calculated during a snowy winter season.

      The economy can also shift what’s normal for an industry—consider the hotel industry’s profit margins during the COVID recession. During the shutdown, some hotels improved their gross profit margin by eliminating room service or reducing housekeeping. But their net profit margin, which included mortgage or rent on a commercial building, probably wasn’t even close to normal.

      And each industry’s typical profit margin range depends on its COGS and operational needs. Think about the difference between a restaurant, a dental practice, and an independent technology consultant—their revenue and expenses are vastly different. Restaurants tend to have high COGS, as meal preparation requires perishable ingredients. The dental practice’s expenses include costly X-ray equipment and malpractice insurance. The technology consultant would most likely have the lowest operating expenses of all 3, as labor would be its main expense. Thus, these businesses’ “normal” net profit margins aren’t comparable to each other.

      You can find industry averages in various online databases, via your favorite trade association, or even by asking the research librarian at your local library—and you can use those ranges, along with knowledge of your own business’s variables, to judge if your margins need improvement.

      Remember, however, that profit margins fluctuate and can be impacted by market conditions. The margins in this chart were calculated in January 2022, during a period of higher-than-normal (8%) inflation.

      IndustryGross profit marginNet profit margin
      Retail (automotive)22.20%4.81%
      Retail (grocery)25.68%1.11%
      Retail (general)24.32%2.65%
      Homebuilding24.87%12.73%
      Construction supplies22.73%7.92%
      Restaurant31.52%12.63%
      Food wholesalers14.85%0.69%
      Information services5.83%16.92%
      Advertising26.20%3.10%
      Recreation39.32%4.78%
      Trucking25.081.85%
      Source: NYU Stern School of Business; data compiled Jan. 2022

      For comparison, this image shows profit margins over time for certain sectors of the retail industry.

      Source: Yardeni.com

      How to Improve Your Small Business’s Profit Margin

      Now that you’ve completed the calculations for your business, how can you increase your profit margin?

      Every business can increase net profit margin (their bottom line) by either increasing revenue or decreasing expenses—or perhaps both. The trick is to understand the business impact of pulling each lever. Will your margins improve more if you raise your prices or negotiate lower pricing with your suppliers?

      For example, a restaurant impacted by rising inventory costs could charge more for each item. But their customers are price-sensitive, so they may choose to reduce expenses instead by cutting portion sizes.

      On the other hand, a consulting business could reduce expenses by modifying internal workflow processes. Suppose a senior consultant spends 5 non-billable hours a week inputting timecards and expenses. In that case, those tasks probably need to be automated or assigned to a lower-cost data entry clerk to minimize labor costs.

      Why Should You Care About Your Profit Margin?

      Numbers are great, but do they really matter? Short answer: yes. Tracking your profit margin can help you to make plans and decisions based on facts, not gut-feel. Scoring a new client can make you feel flush with cash—but only a review of your profit margins will tell you for sure. Remember our dessert example from earlier? Not all profits have the same value.

      Monitoring profit margins also helps you work towards your financial plan. It’s similar to a New Year’s resolution to lose weight: after a week-long cruise vacation, a weigh-in might be a reminder to eat healthy again, but your 6 months of historical weight tracking shows that your long-term plan is working, with only a slight hiccup post-vacation. Profit margins do the same thing for your business—they allow you to make course corrections in the short term while providing context in the overall big picture.

      Profit margins may also be a factor in certain types of small business financing, and a potential lender may review a business’s profit margin before making a decision, especially for more conventional loan products, like a term loan. While the borrower’s ability to service the requested debt is paramount, current debt service and profit are also important to the equation.

      You’re in Charge of Your Profit Margin

      Take steps to calculate and monitor your profit margins regularly. With some minor tweaks to revenue or expenses, you might find your profit margins soaring from okay to outstanding.

      Disclaimer: The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.
      About the author
      Katherine O'Malley

      Katherine O'Malley is a contributor to the Lendio blog. A technology geek at heart, she splits her time between traveling, freelance writing, database administration work, and implementing SEO on her travel blog. In her free time, she loves to research the challenges small-to-midsize tourist suppliers face and find ways that technology can help them out.

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