What's a Good Profit Margin for a New Business?

Starting a business requires more than just a solid idea. There are so many other things to consider, such as how you are going to promote your product and how much you are going to charge your customers. After all, your ultimate goal is to make a profit.

So, how much should you be making?

Before you start selling your products or services to the market, a very important factor to determine is the profit margin. What is it and what is the ideal profit margin for a new business?

Net Margin vs. Gross Margin

Before we dig deeper into this, let us first define what a profit margin is.

Profit margin is the percentage of revenue after deducting all costs – raw materials, depreciation, interest, taxes, and all other expenses. It is often used simply to refer to net margin. But what does it indicate? The profit margin is an important indicator of profitability. It tells the business owner his ability to turn a dollar of revenue into a dollar of profit after considering all the expenses needed to produce and sell the product.

Alright, let’s talk about the two most commonly used profit margins – net and gross margins.

Gross profit margin refers to the money left over from revenues after deducting the cost of goods sold (COGS). The latter only includes the raw materials and expenses directly needed to produce the product and not the indirect costs such as the utility, overhead, payroll, etc. The gross profit margin is calculated by dividing the gross profit over the total revenue and multiplying by 100. So, for example, if you sell a product for $100 which cost you $65 to make, your gross profit margin is 35%.

Meanwhile, the net profit margin refers to the percentage of net income generated from your total revenues. It takes into account all your expenses, not just the COGS. Thus, the net profit margin is a more accurate indicator of your company’s profitability. For example, if you brought in $450,000 in a year and your business expenses totaled $400,000, your net profit margin is 11%.

Factors Affecting Profit Margins

Factors affecting your company’s profit margin are categorized into two – quantitative and qualitative. Quantitative factors include the following:

●     After-tax profit/net profit

●     Merchandise cost

●     Sales prices

●     Inventory

Qualitative factors cover:

●     Your market share

●     Consumer preferences

●     Marketing

●     Seasonal changes

●     Company leadership

●     Sales reward programs

●     Etc.

What’s a Good Profit Margin for New Businesses?

There is no precise number that indicates an ideal profit margin for any business. A good starting point, however, is to compare yours against the average profit margin in your industry. Yes, your industry sector is a major factor that determines your profit margin. For example, businesses offering computer services should aim for around 6.02% profit while those in agriculture should hover around 3.18%.

Knowing your profit margin helps you clearly understand the financial status of your company, which is very important if you’re looking to grow your business. For example, it helps you determine your excess spending, as well as the products which aren’t selling, or the practices/methods that aren’t working for your business. Eliminating these hurdles is an important step towards better profitability. Secondly, understanding your profit margin is essential for financing. When applying for SBA approval depends on where your profit margin stands. Of course, the more profitable your business, the higher your chances of securing financing. There is an alternative way as well for emergency situations, you can consider personal loans online for emergency to cover some minor costs of your business and improve the profit margin.

How to Improve Your Profit Margins

As time goes by, you will realize that one of the most important things you should do to grow your business is to focus on increasing your profit margins. There are many ways to do this. For instance, you may increase your prices, limit discounts, and upsell/cross-sell to increase the unit price of your products. You may also look at cutting production waste, reducing overhead costs, looking for cheaper suppliers, and focusing on just the products that sell. Another way to improve your margins is to boost your marketing. However, before you try any of these approaches, it is important to look at your financial reports to check which strategies are suitable for your business as every company’s situation is different.