Is Your Small Business Profit Margin Good? | Lendio (2024)

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

If you answered “Last week,” excellent! And if you don’t remember, you’re probably way overdue.

But were your numbers good or bad? Every company is unique, so the yardstick you measure your profit margins against isn’t the same one your neighbor uses. What’s considered a “good” range varies across industries—restaurants average a slim 6–8%, whereas the advertising and public relations industry averages a more generous 11–20%.

That means your answer should probably be, “It depends.” Here’s why.

What are profit margins?

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

To go deeper, we cover various different profitability ratios here, including how to calculate them and what their purpose is. The 3 most commonly used are:

  • Net: essentially shows a company’s bottom line
  • Gross: can indicate how well strategies like a price increase are working
  • Operating: can show out-of-control expenses

So what’s the difference between a profit number and a profit margin? Profit numbers show a dollar amount—e.g., a $5 profit on an item sold. Profit margins are a percentage that allows your number to be compared against industry averages and competitors or to reveal trends within your own business.

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

  • Gross profit = net sales – cost of goods sold (COGS)
  • Gross profit margin = (gross profit / net sales) * 100
Vanilla CakeKey Lime Pie
Net Sales$10$20
COGS$5$15
Gross Profit$5$5
Gross Profit Margin50%25%

Both desserts generate a $5 gross profit per unit. However, vanilla cake has a much higher gross profit margin. That kind of insight might influence whether pie stays on the menu or suggest that social media promotions should market the cake.

What should your profit margin be?

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

According to the Corporate Finance Institute, the average net profit for small businesses is 10%, while 20% is considered good. But your mileage may vary depending on a variety of factors.

For example, a company’s size and life stage can heavily influence profit margins. It wouldn’t be reasonable to expect a mom-and-pop retail store to have the same profit margin as a monster retailer like Walmart. Big companies have more leeway for spreading out or reducing costs through automation than small businesses.

Seasonality can significantly alter your margins, too. No one would expect a ski resort’s summertime profitability margins to resemble the values calculated during a snowy winter season.

The economy can also shift what’s normal for an industry—consider the hotel industry’s profit margins during the COVID recession. During the shutdown, some hotels improved their gross profit margin by eliminating room service or reducing housekeeping. But their net profit margin, which included mortgage or rent on a commercial building, probably wasn’t even close to normal.

And each industry’s typical profit margin range depends on its COGS and operational needs. Think about the difference between a restaurant, a dental practice, and an independent technology consultant—their revenue and expenses are vastly different. Restaurants tend to have high COGS, as meal preparation requires perishable ingredients. The dental practice’s expenses include costly X-ray equipment and malpractice insurance. The technology consultant would most likely have the lowest operating expenses of all 3, as labor would be its main expense. Thus, these businesses’ “normal” net profit margins aren’t comparable to each other.

You can find industry averages in various online databases, via your favorite trade association, or even by asking the research librarian at your local library—and you can use those ranges, along with knowledge of your own business’s variables, to judge if your margins need improvement.

Remember, however, that profit margins fluctuate and can be impacted by market conditions. The margins in this chart were calculated in January 2022, during a period of higher-than-normal (8%) inflation.

IndustryGross profit marginNet profit margin
Retail (automotive)22.20%4.81%
Retail (grocery)25.68%1.11%
Retail (general)24.32%2.65%
Homebuilding24.87%12.73%
Construction supplies22.73%7.92%
Restaurant31.52%12.63%
Food wholesalers14.85%0.69%
Information services5.83%16.92%
Advertising26.20%3.10%
Recreation39.32%4.78%
Trucking25.081.85%

How to improve your small business’s profit margin.

Now that you’ve completed the calculations for your business, how can you increase your profit margin?

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

For example, a restaurant impacted by rising inventory costs could charge more for each item. But their customers are price-sensitive, so they may choose to reduce expenses instead by cutting portion sizes.

On the other hand, a consulting business could reduce expenses by modifying internal workflow processes. Suppose a senior consultant spends 5 non-billable hours a week inputting timecards and expenses. In that case, those tasks probably need to be automated or assigned to a lower-cost data entry clerk to minimize labor costs.

Why should you care about your profit margin?

Numbers are great, but do they really matter? Short answer: yes. Tracking your profit margin can help you to make plans and decisions based on facts, not gut-feel. Scoring 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 dessert example from earlier? Not all profits have the same value.

Monitoring profit margins also helps you work towards your financial plan. It’s similar to a New Year’s resolution to lose weight: after a week-long cruise vacation, a weigh-in might be a reminder to eat healthy again, but your 6 months of historical weight tracking shows that your long-term plan is working, with only a slight hiccup post-vacation. Profit margins do the same thing for your business—they allow you to make course corrections in the short term while providing context in the overall big picture.

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

You’re in charge of your profit margin.

Take steps to calculate and monitor your profit margins regularly. With some minor tweaks to revenue or expenses, you might find your profit margins soaring from okey to outstanding.

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

Is Your Small Business Profit Margin Good? | Lendio (2024)

FAQs

Is Your Small Business Profit Margin Good? | Lendio? ›

The answer is—it depends. According to the Corporate Finance Institute, the average net profit for small businesses is 10%, while 20% is considered good. But your mileage may vary depending on a variety of factors. For example, a company's size and life stage can heavily influence profit margins.

What is a good small business profit margin? ›

What's a good profit margin for a small business? Although profit margin varies by industry, 7 to 10% is a healthy profit margin for most small businesses. Some companies, like retail and food, can be financially stable with lower profit margin because they have naturally high overhead.

How do you know if profit margin is good? ›

An NYU report on U.S. margins revealed the average net profit margin is 7.71% across different industries. But that doesn't mean your ideal profit margin will align with this number. As a rule of thumb, 5% is a low margin, 10% is a healthy margin, and 20% is a high margin.

Is 50% profit margin good in a small business? ›

A gross profit margin of over 50% is healthy for most businesses. In some industries and business models, a gross margin of up to 90% can be achieved. Gross margins of less than 30% can be dangerous for businesses with high gross costs.

Is a profit margin of 40% good? ›

The 40% rule is a widely used benchmark for assessing a startup's financial health and the balance between growth and profitability. This rule of thumb emphasizes that a company's growth rate and profit, typically represented by the operating profit margin, should collectively reach 40%.

What is a normal profit for a small business? ›

Net profit margins vary by industry but according to the Corporate Finance Institute, 20% is considered good, 10% average or standard, and 5% is considered low or poor. Good profit margins allow companies to cover their costs and generate a return on their investment.

What is a profit margin example? ›

For example, if the net income of the organization is $30,000 and its net sales is $45,000 then you can perform the following calculation:Profit margin = ($30,000 / $45,000) x 100Profit margin = (0.667) x 100Profit margin = 66.7%This figure represents the sum that the business gets to keep after paying its expenses.

What does a good gross profit margin look like? ›

On the face of it, a gross profit margin ratio of 50 to 70% would be considered healthy, and it would be for many types of businesses, like retailers, restaurants, manufacturers and other producers of goods.

How do I comment on the profitability of a company? ›

Factors like net profit margin, profit margin, operating expenses, per-client profit, and future projects are helpful profitability indicators. Measuring these on a regular basis makes it easier to catch any low-profit areas and quickly rectify them.

Do you want a low or high profit margin? ›

Do You Want a High or Low Profit Margin? In all cases, high. A higher the number (compared to the company's industry standard), the more confidence investors will have because the number is a direct reflection of how the business is being operated and expenses are being managed.

Is 60% profit margin too high? ›

Ideally, direct expenses should not exceed 40%, leaving you with a minimum gross profit margin of 60%. Remaining overheads should not exceed 35%, which leaves a genuine net profit margin of 25%. This should be your aim.

How much profit margin do I need? ›

Generally speaking, a good profit margin is 10 percent but can vary across industries. To determine gross profit margin, divide the gross profit by the total revenue for the year and then multiply by 100. To determine net profit margin, divide the net income by the total revenue for the year and then multiply by 100.

Are low profit margins bad? ›

If you have a low profit margin this means that the selling price you chose for goods isn't much higher than its cost. If your company has a low profit margin, you're likely in a very competitive industry, offering products that aren't highly unique. But there are still many ways that you can increase your net profit.

Is 30% profit margin too high? ›

While the overall average sits above 30%, there is a wide disparity in gross profit margins between regional banks (99.75%) and automotive businesses (9.04%), for example. Generally speaking, service industries that do not sell physical products will post higher gross profit margins because they have a much lower COGS.

What business has the best profit margin? ›

According to NYU Stern, the financial sector has come out as the most profitable sector with banks reporting gross profits of almost 100%. The net income for the same sector lies around 30%. Followed by financials, is the oil and gas industry with net profits nearing 28.26% and gross margins of 58.75%.

Is 35% gross profit margin good? ›

A good target for gross margin is 50%; and a good target for net profit is 10%. Gross margin is the total revenue minus your direct cost. The gross margin rate is the gross margin divided by total revenue. Direct costs are the costs that you need to spend to deliver your product or service.

Is 20% profit margin good? ›

You may be asking yourself, “what is a good profit margin?” A good margin will vary considerably by industry, but as a general rule of thumb, a 10% net profit margin is considered average, a 20% margin is considered high (or “good”), and a 5% margin is low.

How much profit should a business make in the first year? ›

Most businesses don't make any profit in their first year of business, according to Forbes. In fact, most new businesses need 18 to 24 months to reach profitability.

What is a 75% profit margin? ›

Gross profit margin is a metric that measures profit by taking "total sales revenue" and subtracting it by the "cost" to make the product (COGS). For example, if you sell a ham and cheese sandwich for $4 and the ingredients cost $1 to make, the gross profit margin is 75% regardless of tax, labor or electricity costs.

What business has the highest profit margin? ›

According to NYU Stern, the financial sector has come out as the most profitable sector with banks reporting gross profits of almost 100%. The net income for the same sector lies around 30%. Followed by financials, is the oil and gas industry with net profits nearing 28.26% and gross margins of 58.75%.

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