Wondering how to calculate your small business profit margin and how it can apply to your finances? Look no further: we’re breaking down the metric so you can better understand your company’s financial health.
What is a Profit Margin?
A company’s operating profit margin, also referred to as its return on sales, measures the proportion of income to revenue. This number reveals how much profit your business is generating from sales, and can help you set goals and gauge your progress. Plus, lenders like SmartBiz may require you to present your business’s profit margin to get a sense of its financial health.
How to Calculate It
There are two main types of profit margins small business owners can use to calculate: gross profit margin and net profit margin. Here’s how they break down:-
- Gross profit margin: This measurement is used to determine the profitability of a certain product, not of the entire business operations. So if it costs you $40 to make a single product but you sell it for $50, your gross profit margin will be $10 divided by $50, which is 20%.
- Net profit margin: You’ll most likely use this calculation to judge how profitable your business is overall. Take your company’s total sales for a specific time period, subtract your total expenses, and then divide that number by your total revenue. So if your business made $500,000 last year and had expenses of $350,000, your net profit margin would be ($500,000-$350,000)/$500,000 = 0.30, or 30%.
Good Profit Margins
When it comes to ideal profit margins, there’s no single number to look for. Unless you include your industry, your expansion goals, and your unique business situation, comparing your profit margins to other businesses’ won’t tell you much.
- Industry averages: With data like NYU’s Margins by Sector, you can see how your company stacks up against the industry benchmark. Don’t forget to take your geographic area into account too.
- Business growth: A healthy profit margin will also depend on your expansion plans. When you’re looking to make a large purchase, you might want your profit margins to be slightly higher so you can budget for the future.
- Business age and size: As a rule of thumb, newer businesses usually have higher profit margins because of lower overhead costs. As operations grow, profit margins might come down.
Improving Profit Margin
Once you know where you stand, you may want to look into improving your profit margin year over year. Some areas to consider are operating expenses and sales. If you find certain products are too costly to maintain or find opportunities to boost incoming revenue, make sure to act on those chances at growth.
Understanding your business’s profit margin takes paying attention to your individual situation. With the right tools, you can use the number to discover areas for growth and expansion.
Get started with SmartBiz Advisor today to receive personalized insights and recommendations on your small business. This free, online, AI-based tool is based on our lending partners’ key criteria and can help you learn more about qualifying for the low-cost funding you deserve.
* The information provided through SmartBiz Advisor, including the Loan Ready Score, is for educational purposes and is not the same as scores used by lenders for credit decisions. SmartBiz Advisor is not a financial or legal advisor as defined under federal or state law. Use of this information is not a replacement for personal, professional advice or assistance regarding your finances or credit history.