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 higher the percentage, the more profitable your business is.
Step 1: There is a difference between gross profit, gross margin, and net profit.
The gross profit is the total revenue you make from your goods or services.Expenses like payroll, rent, or utilities are not included in the calculation because it only considers the cost of creating those goods and services.Revenues are divided by gross profit margin.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 need to include any additional earnings, such as investment income.Net profit is what is used to manage the business.The steps below show you how to find this number.The bottom line is also referred to as net profit.
Step 2: Determine the period for your calculation.
Pick 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 would 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.If you're comparing your profit margin between different months for your own purposes, it's fine to use shorter periods of time.
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, like 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 adjust for returns and discounts.If you provide services such as lawn mowing, your total revenue is all of the money you collected during the period.If the business involves owning securities, you should include the interest and dividends from those sources in your total revenue calculation.
Step 4: To calculate net income, subtract all your expenses.
Revenue is the opposite of expenses.They're the amounts you have to pay or will pay in the future for things you did during the calculation period.Expenses incurred to operate as well as the expense required to carry investments are included.Common expenses include 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 and spent $70,000 on rent, supplies, equipment, taxes, and interest payments, you subtract $70,000 from your remaining revenue.
Step 5: You already calculated the total revenue, divide it by your net income.
The profit margin is the percent of revenue you keep as income.We had a difference of $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?Your business netted $30,000 in cash after $100,000 in sales.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's 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 how much profit margin they expect for your size and business type.If you are a large company with competitors, you can compare their profit margins to yours.Company 1 has $500,000 in revenue and $220,000 in expenses.This would give it a profit margin of more than 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.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 profit margin of 3%, while technology and software companies have a 20% margin.If you compare your company to a larger one, make sure it's meaningful.
Step 9: If you have to, adjust your profit margin.
If you want to change your profit margin percentage, you can either make more 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.The reverse effect of tanking your business is if you increase your profit margin too aggressively.There is no need to confuse profit margins with markup.There is a difference between what it costs to produce and how much it is sold for.