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Is Your Small Business Profit Right?

Quick—when was the last time you calculated your business’s profit margin?

If you answered “Last week,” that’s great! And if you don’t remember, it’s probably too late.

But were your numbers good or bad? Every company is different, so the sticker you use to measure your profit margins isn’t the same as your neighbor’s. What is considered a “good” range varies across industries—restaurants have a minimum average of 6–8%, while the advertising and public relations industry averages 11–20%.

That means your answer should be, “It depends.” Here is the reason.

What are the benefit limits?

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

In depth, we cover a variety of different profitability ratios here, including how they are calculated and what their purpose is. The 3 most commonly used are:

  • Total: it actually shows the line of the company
  • Total: it can show how effective strategies such as price gouging are
  • Performance: it can show unmanageable costs

So what is the difference between a profit number and a profit ratio? Profit numbers indicate a dollar amount—eg, a $5 profit on an item sold. Profit margins They are percentages that allow your number to be compared to industry and competitor averages or to reveal trends within your business.

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

  • Net profit = gross sales – cost of goods sold (COGS)
  • Gross profit margin = (gross profit / total sales) * 100
Vanilla cake Key Lime Pie
Total Sales $10 $20
COGS $5 $15
Gross profit $5 $5
Gross Profit Margin 50% 25%

Both desserts make a profit of $5 per unit. However, the vanilla cake has a very high profit margin. That kind of insight might influence whether a pie stays on the menu or suggest a social media promotion should market the pie.

How much should your profit be?

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

According to the Corporate Finance Institute, the average profit margin for small businesses is 10%, and 20% is considered good. But your mileage may vary depending on various factors.

For example, a company’s size and life stage can have a significant impact on profits. It would be unreasonable to expect a mom-and-pop retail store to have the same profit margin as a monster retailer like Walmart. Large companies have more freedom to spread out or cut costs automatically than small businesses.

The time of year can drastically change your margins, too. No one would expect a ski resort’s summer profit margins to match the profits made during the snowy winter season.

The economy can also change industry norms—consider the hotel industry’s profit margins during the COVID-19 recession. During the shutdown, some hotels improved their gross profit margins by eliminating room service or reducing housekeeping. But their net income margin, which includes loans or rent on commercial property, was probably not even close to normal.

And the scope of each sector’s profit margin depends on its COGS and operational requirements. Think of the difference between a restaurant, a dental practice, and an independent technology consultant—their income and expenses are very different. Restaurants tend to have high COGS, as food preparation requires perishable ingredients. The cost of dental work includes expensive X-ray equipment and malpractice insurance. A technical consultant will probably have the lowest operating costs of the 3, as labor would be their primary cost. Therefore, the “average” profit margins of these businesses are not comparable.

You can find industry averages from various online sources, through your favorite trade association, or by asking a librarian at your local library—and you can use those rankings, along with knowledge of your own business variables, to judge if your parameters need improvement.

Keep in mind, however, that profit rates are variable and can be affected by market conditions. The margins in this chart were calculated in January 2022, during a period of high inflation (8%).

Industry Gross profit margin Gross profit margin
Retail (cars) 22.20% 4.81%
Retail (grocery) 25.68% 1.11%
Retail (general) 24.32% 2.65%
Building a home 24.87% 12.73%
Building materials 22.73% 7.92%
Restaurant 31.52% 12.63%
Food vendors 14.85% 0.69%
Information services 5.83% 16.92%
Advertising 26.20% 3.10%
For recreation 39.32% 4.78%
Trucks 25.08 1.85%
Source: NYU Stern School of Business; data compiled Jan. 2022

How to improve the profit margin of your small business.

Now that you have completed your business calculations, how can you increase your profit margin?

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

For example, a restaurant affected by rising inventory costs may charge more per item. But their customers are price sensitive, so they may choose to cut costs by cutting portion sizes.

On the other hand, a consulting business can reduce costs by streamlining internal workflow processes. Let’s say a senior consultant spends 5 non-billable hours per week entering time and expense cards. If so, those tasks probably need to be automated or outsourced to a low-cost data entry clerk to reduce labor costs.

Why should you care about your profit margin?

The numbers are big, but do they really matter? Short answer: yes. Tracking your profit margin can help you make plans and decisions based on facts, not gut feeling. Landing 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 previous example? Not all benefits are equal.

Monitoring profit margins also helps you work on your financial plan. It’s like a New Year’s resolution to lose weight: after a week-long cruise vacation, weighing yourself may be a reminder to eat healthy again, but your 6-month weight-tracking history shows that your long-term plan is working, with a minor hiccup after the vacation. Profit margins do the same thing for your business—they allow you to make course corrections in the short term while giving context to the bigger picture.

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

You are in charge of your profit margin.

Take steps to calculate and monitor your profit margins regularly. With some minor adjustments in revenue or expenses, you can find your profit margins going from ok to great.

*Disclaimer: The information provided in this post is not, and is not intended to constitute, business, legal, tax, or accounting advice and is provided for informational purposes only. Students should contact their attorney, business advisor, or tax advisor for advice on any matter.

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