A business’ profit margin is a key piece of information about whether or not the business is making money.Monitoring your business’ profit margin is one of the things you will need to do to create a good business plan.The more profitable your business is, the higher the profit margin is.
Step 1: There is a difference between gross profit, gross margin, and net profit.
The cost of producing or providing those goods or services is known as gross profit.Expenses like payroll, rent, or utilities are not included in this calculation because it only considers the cost of creating those goods and services.The gross profit margin is the difference between the revenue and the profit.Net profit takes all business expenditures into account and is calculated as gross profit minus administrative expenses.Regular operational costs include payroll, rent, etc.One-time costs include taxes, contractor invoices, etc.You have to include any additional earnings, such as investment income.Net profit is what is used to manage the business.The steps below show how to find this number.The bottom line is also referred to as net profit.
Step 2: Determine the period for your calculation.
Determine the period of time you want to analyze to calculate your business’s profit margin.People use months, quarters or years to calculate their profit margins.Why do you want to calculate your margins?If you are applying for loans or looking to attract investors, they will want to know more than just how your business did over a single month.It’s fine to use shorter periods of time if you’re comparing your profit margin between different months.
Step 3: The total revenue generated by your business can be calculated.
The revenue comes from the sale of goods, services, or earnings of interest.If your business only sells goods, such as a retail shop or restaurant, your total revenue is all the sales you had during the period, minus any returns or discounts.If you don’t already have this figure on hand, you can use the total number of items you sold by the price of each item and then adjust for returns and discounts.If you provide services such as lawn mowing, your total revenue is all of the money you collected.If the business involves owning securities, you should include the interest and dividends from those sources in your total revenue calculation.
Step 4: Subtract your expenses from your net income.
Revenue is the opposite of expenses.They are the amounts you have to pay or will pay in the future for things you did during the calculation period.Expenses incurred to operate and carry investments are included.Common expenses are the cost of labor, rent, electricity, equipment, supplies, inventory, banking, and interest on loans.If you run a small business, you can add up all the costs you paid during the period.If your business earned $100,000 in revenue during the calculation period, but spent $70,000 on rent, supplies, equipment, taxes, and interest payments, you subtract $70,000 from your remaining revenue.
Step 5: Divide your net income by revenue.
The profit margin is the percent of revenue that you keep as income.Our difference was $30,000.When a person pays for a painting, the profit margin calculation tells you how much of that money you will keep in profit.
Step 6: Determine if your profit margin meets your needs.
Consider your profit margin and the amount of sales you make in a year if you plan to live solely off income from your business.Is the remaining profit enough to sustain your lifestyle when you take out the rest of your income?After $100,000 in sales, your business netted $30,000 in cash.If you use $15,000 of the profit to invest in your business, you have $15,000 left over.
Step 7: Take your profit margin and compare it to other businesses.
It is useful to compare your profit margin to similar businesses to see where you stand.If you apply for a loan, the bank will likely tell you the profit margin they expect for your size and business type.If you are a large company with competitors, you can research them and compare their profit margins to yours.Company 1 has $500,000 in revenue and $230,000 in expenses.It would have a profit margin of over 50%.Company 2 has revenue of $1,000,000 and expenses of $580,000.Company 2’s profit margin is 42%.Even though Company 2 makes double of what Company 1 does, it has a higher net profit.
Step 8: When comparing profit margins, compare apples with apples.
Depending on their size and industry, companies have different profit margins.In order to make the most of the comparison, it is best to compare two or more companies in the same industry and with similar revenues.The airline industry has a 3% profit margin, while technology and software companies have a 20% margin.If you are comparing your company to another, make sure it is meaningful.
Step 9: If you have to, adjust your profit margin.
If you want to change your profit margin percentage, you can either increase revenue or reduce expenses.If you increase your total revenue and expenses, your net income will increase in dollar value.As you experiment with raising prices or cutting costs, consider your business, competition, and risk tolerance.If you want to prevent a dive in business or angering your customers, you should make small changes and work up to larger ones.Increasing your profit margin too aggressively can have the reverse effect of tanking your business.It’s not a good idea to confuse profit margins with markup.There is a difference between what it costs to produce and how much it is sold for.