Every small business owner opens his/her business with a dream and a desire to make money. Yet, while the business may have a significant aspirational beginning, there can be no business without profits and no long-term tenure and growth without healthy profit margins.
What are profit margins?
Profit margins are the measures of what a company makes beyond what it costs to produce goods or to create services. Three profit margin measures provide insight into the health of a business and are used by business owners, accountants, lenders, creditors, and investors to make informed judgments about a business.
- Gross profit equals a company’s revenue minus its cost of goods or services sold, and the margin mathematically is gross profit divided by revenue times 100.
- Operating profit equals a company’s revenue minus the cost of goods or services sold and minus the company’s operating expenses. The operating profit margin is mathematically calculated as operating profit divided by revenue times 100.
- Net profit margin (the most important) equals revenue minus cost of goods or services sold, minus operating expenses, minus interest, minus taxes. It is calculated as net profit divided by revenue times 100.
Healthy profit margins are necessary to propel continued business success.
What does it mean to have “healthy” profit margins?
A New York University report in 2020 indicated that the net average net profit margin for business was 7.71 percent across industries. The NYU report suggests that 5 percent is considered a low margin, 10 percent a very healthy margin, and 20 percent a high margin. However, margin figures have a great deal of variability across industries. For example, grocery stores, retail outlets, and restaurants typically have low margins, and regional banks, consulting firms, and software companies have high margins.
Other factors in evaluating margins include the age and size of a business and geographic factors that impact costs. Consider, for example, the costs to operate a business in San Francisco, CA versus Cheyenne, WY. And further, how a profit margin is evaluated depends on the growth goals of a business.
Thus, it is important to thoughtfully utilize financial data to measure and help achieve healthy profit margins.
How to achieve healthy profit margins
Healthy profit margins can indicate a lot about a business including how profitable, sustainable, and stable a business is, how it compares to the competition, and how attractive it may be to investors.
Achieving healthy profit margins can be accomplished these ways:
- Carefully examine operational costs and find ways to reduce costs. That may be accomplished by better management of inventories, better hiring and staffing efficiencies, finding the best deals on utility, internet, and reducing operating supplies costs. Small improvements can lead to important margin increases.
- Eliminate low-margin offerings or slow-moving products or services to focus on the things that bring in more revenue.
- Examine pricing to take appropriate price increases due to increasing costs or pricing moves made by competitors. But make pricing increases with great care to not alienate customers.
- Implement or improve loyalty programs to increase the sales contributed by your best customers.
- Find ways to increase brand value. That may be in offering distinctive new offerings, improving customer service, investing in more attractive packaging, or in marketing the business.
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