Taking in revenue is essential for any small business. However, the dollar figure means little if you don’t subtract the money you spent to earn it. This calculation provides you with your company’s profit margin. According to the S & P 500, the average profit margin a year ago was just over 11 percent. While the number that you end up with depends largely on your industry, you want the percentage to be as high as possible. The danger of having a low-profit-margin is that it leaves your company too vulnerable to marketplace changes beyond its control.
How to Figure Profit Margin
The most common way to determine a profit margin is to subtract total costs from total revenue. Costs typically include things such as payroll, product manufacturing, marketing, taxes, interest paid on loans, and depreciation. Examples of revenue include any money paid to your company for its products or services, interest paid, and gains from investments. In short, your company’s profit margin is the sum of total sales minus total expenses divided by total sales. You might also want to calculate the gross profit margin or net profit margin.
Gross profit margin is a method used to determine how much a company made on a single product or service. The way to figure this calculation is to subtract the cost of labor and materials from the retail price the customer paid for it. The net profit margin typically refers to the financial value of an entire organization. With this method, you would calculate all sales for a specified timeframe and subtract all expenses for the same reporting period. Next, you would divide this figure by your company’s total revenue to come up with its gross profit margin.
Why It’s Important to Know Your Company’s Profit Margin
The most practical reason to know your company’s profit margin is that lenders require it. You have a higher chance for loan approval if you know this percentage in advance and it’s at least an average number for your industry. Knowing your profit margin also helps you detect problem areas where the company is spending too much money and making too little in return on specific products and services. It can also help to pinpoint issues such as poor financial management in general.
Factors That Determine Profit Margin and How to Improve It
Your industry, the current state of the economy, and the amount of overhead your business has are just some of the unique factors that help determine whether your business is as profitable as it could be. The size of your company, how long you have been in business, and whether you plan to expand, all play a role as well.
If you feel disappointed with the profit margin, try decreasing expenses, increasing product or service offerings, or eliminating underperforming products, services, or employees. You can also work with Capital Business Strategies to help improve your profitability. Please request a consultation today to learn more.