You think your small business is doing well — you have loyal customers and you’re selling consistently. You try your best to keep expenses under control, too. But how do you know where your small business stands?
That’s where your profit margin comes in.
A business’s profit margin reflects its profitability, stability, sustainability and overall financial health. It’s also a metric investors look at when comparing your business to competitors. But all of this begs the question: “What’s a good profit margin?”
While it varies by industry, a business can usually measure its profit margin against an agreed-upon range. Here’s how to calculate your profit margin to determine if you’re in the “good” range.
What’s a good profit margin?
A general rule of thumb is that 5% is a low profit margin, 10% is a healthy profit margin, and 20% or more is a high profit margin. However, there isn’t a profit margin perfect for all business types.
There are three types of profit margins:
- Net profit margin is best for understanding your business’s overall profitability.
- Gross profit margin helps business owners understand the profitability of a single item.
- Operating profit margin reflects how well a company manages its expenses.
What’s considered a good profit margin is different for each type. Usually, a business will use net profit margin to give the clearest picture of its performance.
Net profit margin
Net profit is what’s left after the cost of goods sold, operating expenses and non-operating expenses (such as interest, taxes and depreciation) are deducted from your total revenue. A good net profit margin is typically between 5% and 10%.
Of the three profit margins, net profit margin is the best indicator of business performance — and what owners look at when determining if their profit margin is “good.” Like net income, which is the bottom line of a company’s income statement, net profit margin factors in all total expenses, including direct costs and indirect costs.
To find your net profit margin, first use this formula to find net profit:
Revenue – cost of goods sold – operating expenses – interest – taxes = net profit
Then, divide net profit by revenue and multiply that number by 100.
(Net profit / revenue) x 100 = net profit margin
Gross profit margin
Gross profit margin reflects the remaining revenue after the cost of goods sold (COGS) is deducted. COGS is the total cost of creating the products or services you sell. COGS includes expenses such as raw materials, wages and factory overhead expenses.
Gross profit margin helps business owners understand how profitable specific items are, rather than the entire business.
For many types of businesses, such as retailers, restaurants and manufacturers, 50% to 70% is considered a good gross profit margin. However, businesses that provide services rather than physical goods usually have a gross profit margin of about 90%. These business types have a much lower cost of goods, as they do not create tangible items.
To calculate gross profit margin, first calculate gross profit.
Revenue – cost of goods sold = gross profit
Then, divide gross profit by revenue and multiply that number by 100.
(Gross profit / revenue) x 100 = gross profit margin
Operating profit margin
Operating profit is income remaining after COGS and operating expenses are deducted. While COGS is the cost of making your products, operating expenses are the cost of keeping your business running. Operating costs include COGS, but can also include production costs, labor costs, overhead costs, rent and payroll. Interest payments and taxes are not included in this calculation.
Operating profit margin is a good metric for how well a company manages its expenses. Most operating expenses are variable costs — they can be controlled by management — rather than fixed expenses, such as material costs.
The average operating profit margin is about 10%. A good operating profit margin to aim for is 15% and above.
To calculate your company’s operating profit margin, first calculate operating profit.
Revenue – costs of goods sold – operating expenses – other day-to-day expenses = operating profit
Then, divide operating profit by revenue and multiply that number by 100.
(Operating profit / revenue) x 100 = Operating profit margin
Average profit margins by industry
Below is a selection of industries and their average net profit margins. A full list is available on NYU’s U.S. Margins by Sector database, which also includes gross margins, operating margins and net margins. The data is updated yearly.
Keep in mind that different industries operate using different business models, which affect what is considered a “good” profit margin. The age of a company and its size also affect profit margins. New businesses typically have higher profit margins and more established businesses typically have lower profit margins.
When comparing your company’s profit margin with the competition, take sector, age and size into account.
- Apparel: 5.07%
- Auto and truck: 5.02%
- Electronics (general): 6.32%
- Engineering and construction: 2.16%
- Farming and agriculture: 5.66%
- Household products: 11.25%
- Real estate (development): 15.04%
- Restaurants and dining: 9.28%
- Retail (general): 2.35%
- Retail (grocery and food): 1.96%
- Retail (online): 0.64%
- Transportation: 6.99%
Ways to improve your profit margin
You can improve your business’s profit margin by cutting back on business expenses and improving your sales.
Reduce operating expenses. Operating expenses are the costs of keeping a business running. These can include rent, wages, cleaning services, business software, materials and supplies. Think about which expenses you could reduce or eliminate. Could you cut back on employee spending? Can you get a lower insurance rate?
Adjust your prices. If your cost of goods has increased, you may need to increase your product’s cost to reflect that. There are different pricing strategies to consider adopting, such as value-based pricing or cost-plus pricing.
Retain existing customers. Gaining new customers through advertising is expensive. Try creating a customer loyalty program or another customer retention strategy to increase sales from existing customers. This can reduce your advertising costs.
Increase sales. Making more profit while maintaining your current expenses will increase your profit margin. Try these strategies to increase sales for small business owners.
Related Articles
