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A good profit margin depends on your industry, which you can benchmark off an index like S&P 500. While advertising has a net margin of 6.04%, the alcohol industry has a net margin of 19.13%. Similarly, computer services can expect to make 6.02% profit, while farming/agriculture hovers around 3.18%. S&P 500 reports the blended net profit margin for Q1 2018 to be 11.6%. Profit margins above 11% outperform those of the market, but a profit margin under 15%-20% indicate vulnerability to negative market changes.
More money is good money, right? In most cases, yes, but small business owners must also take into account another, slightly more complicated metric: the profit margin. In other words, what percentage of your revenue comes out as a profit against all your business costs and expenses?
While it seems logical, there are many things small business owners either don’t know or forget about profit margins—including what your profit margin goals should be to begin with. In fact, according a 2013 Reason-Rupe poll, most people believe that business profit margins hover around 36%—which is about 5X too high! See our helpful guide to assess good profit margin goals for your small business below.
First off, what is a profit margin?
While there are slight variations on the definition, a profit margin typically represents the percent of revenue earned after all costs, taxes, depreciations, interests, and other expenses have been deducted.
To calculate profit margin of a business, most organizations use the following formula (though we explain other ways to calculate below):
Profit Margin = (Total Sales – Total Expenses)/Total Sales
Of course, it’s good practice to have a thorough, accurate understanding of your business’s financials, but these are a couple of other reasons you should track your profit margins:
So, how do you calculate your small business profit margin?
It depends on what you’re trying to measure. According to the QuickBooks Resource Center, there are two types of profit margins that small businesses can measure:
How much do you calculate? In short, everything. In order to get an accurate look at what your small business’s profit margin is, you need to look at all the details.
You need to keep track of everything: from expenses like payroll, utilities, and shipping to every source of revenue, including the small stuff like transaction fees or maintenance contracts. This gives you a very clear picture of your company’s profit margins, so you have to be extra careful not to miscalculate or leave anything off the books. OmniCalculator is a great online tool for helping you determine profit margins.
A good profit margin very much depends on your industry and expansion goals and a host of other factors, like the economy. It can sometimes seem like comparing apples to oranges.
Industries with hardly any overhead costs, like consulting, for example, have higher profit margins than, say, a restaurant, which pays overhead costs in facilities, payroll, inventory, and so on. S&P 500 reports the blended net profit margin for Q1 2018 to be 11.6%. Profit margins above 11% outperform those of the market, but a profit margin under 15%-20% indicate vulnerability to negative market changes. Again, it’s hard to compare every small business against this average as all businesses are unique and operate differently.
See some factors that affect what makes a “good” profit margin below:
More example industry profit margins from the NYU study:
Of course, knowing what is a good profit margin and understanding your profit margin is the first step in improving your margins. Once you have that data, these are just a few ways you can help your business improve its profit margin:
Profit margins can be tricky—both determining them and understanding what’s right for your business. Do your research for your industry and make sure to track, track, track those numbers down to every last expenditure and revenue source. Knowing where you are with your profit margin helps you determine where to go next, and it’s different for every business.