profit margin operating margins net business
What is a good profit margin?As the name suggests, profit margin refers to the money that remains after youdeduct your small business expenses. It’s a percentage that measures howprofitable your pricing strategy is, how well you control costs, and howefficiently you use raw materials and labor to produce your products orservices.But once you know what profit margin is and why it matters, the next logicalquestion is, “What is a good profit margin for my line of business?” Theanswer varies by location, industry, business model, age of the business, andgrowth goals. And major economic events like the COVID-19 shutdown tend toshrink every company’s margins.Below, you’ll find three formulas to calculate profit margin, a handy list ofaverage profit margins by sector, and tips to give your margins a boost.## Types of profit marginThere are three types of profit margins business owners, accountants, lenders,creditors, and investors rely on. You can calculate your company’s grossprofit margin, operating profit margin, or net profit margin.Each of these three formulas provides unique insight into your financialhealth, and helps you make informed business decisions. Read our breakdown ofeach margin to learn more.### Gross profit marginGross profit is the revenue that remains after you deduct the cost of goodssold (COGS). COGS refers to the costs necessary to produce or manufacture yourproducts or services. Some examples include raw materials, labor wages, andfactory overhead expenses.Gross profit can be found using the following formula:Gross profit = revenue – cost of goods soldAfter you calculate gross profit, you can determine the gross profit marginusing this calculation:Gross profit margin = (gross profit ÷ revenue) x 100Generally, gross profit margin is a better way to understand the profitabilityof specific items rather than an entire business. A business with strong totalsales could seem healthy on the surface, but might actually suffer losses ifhigh operating expenses aren’t considered. Calculating gross margin can showyou if you’re spending too much time or labor on a certain product or service.### Operating profit marginOperating profit is the income left after you deduct the cost of goods sold(COGS) and operating expenses (OPEX). We’ve already defined COGS as the directcost of creating your products or services. By contrast, operating expensesrefer to the costs that keep your business up and running. This categoryincludes items like rent, payroll, marketing, and inventory software. Costslike interest payments and taxes aren’t included.First, calculate your operating profit:Operating profit = revenue – cost of goods sold – operating expensesThen, you can use the operating profit margin formula:Operating profit margin = (operating profit ÷ revenue) x 100For a more accurate picture overall, it’s best to use the operating profit ornet profit margin.### Net profit marginNet profit is what remains after you deduct COGS, OPEX, interest, and taxes.Find your net profit using this formula:Net profit = revenue – cost of goods sold – operating expenses – interest –taxesAfter that, plug your variables into the net profit margin formula:Net profit margin = (net profit ÷ revenue) x 100Net profit margin is one of the best indicators of company profitabilitybecause it accounts for your major direct and indirect costs. And that’s whynet income is the bottom line of the income statement, which reports acompany’s profit and losses over time. It’s the big takeaway after you’vetallied up earnings and costs.### Expect differences between your gross, operating, and net marginsA great way to illustrate the differences between the margin formulas is tolook at a real-world example. Check out Amazon’s margins as of March 2020: * Gross profit margin: 26.06% * Operating profit margin: 5.29% * Net profit margin: 3.36%Each margin accounts for a little more of your company spending, so yourprofits are likely to shrink from formula to formula. That said, your businessmay have a less drastic drop-off between gross profit margins and the othertwo margins.Keep in mind a lucrative global company like Amazon will have operatingexpenses and other costs that far outstrip most small businesses. So, they canexpect their operating and net margins to be thinner.## What is a good profit margin?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 marginwill align with this number.As a rule of thumb, 5% is a low margin, 10% is a healthy margin, and 20% is ahigh margin. But a one-size-fits-all approach isn’t the best way to set goalsfor your business profitability.First, some companies are inherently high-margin or low-margin ventures. Forinstance, grocery stores and retailers are low-margin. They have highexpenses, as they need to purchase inventory, employ corporate employees andlabor workers, facilitate shipping and distribution, and rent biggerfacilities as their sales grow. But low-margin goods, like food and someconsumer products, are usually easier to sell. A highly competitive market,like the rideshare war between Uber and Lyft, can also create thin margins.By contrast, businesses like consulting firms and software-as-a-service (SaaS)companies generally have high gross margins. These businesses have feweroperating costs, no inventory, and require less startup capital to launch.Companies that sell high-dollar products, like jewelry stores, can also fallinto this category. Read more here about the most profitable and leastprofitable industries.Business age and size play a role in profit margins as well. New businessesoften have higher profit margins than large or established firms. Generally,there are fewer sales, fewer people on payroll, and therefore, lower overheadcosts. As operations expand, margins usually shrink.A geographic area can also alter margins for businesses in the same industry.For example, a tech company in San Francisco will have wildly different rentand payroll costs than a tech company in Dallas.Finally, a good profit margin depends on your growth goals. If you plan totake on investors soon, need to finance a large equipment purchase thisquarter, or want to expand your services, you’ll need to increase yourmargins. We’ll give you tips on how to do this soon.## Average profit margins by industryYour profit margin can tell you how well your business performs compared toother market players in your industry.Although there’s no magic number, a good profit margin will typically fallbetween 5% and 10%. Below, we’ve compiled the net profit margins for commonsmall business sectors. * Advertising: 3.30% * Apparel: 5.87% * Auto and truck: 3.04% * Auto parts: 3.05% * Beverage (alcoholic): 7.94% * Beverage (soft): 18.50% * Brokerage and investment banking: 17.62% * Building materials: 4.30% * Business and consumer services: 3.83% * Computer services: 4.34% * Drugs (pharmaceutical): 18.38% * Education: 9.59% * Electronics (consumer and office): -3.14% * Electronics (general): 5.70% * Engineering and construction: 1.00% * Entertainment: 11.73% * Farming and agriculture: 2.47% * Financial services (non-bank and insurance): 26.94% * Furniture and home furnishings: 5.15% * Healthcare products: 9.27% * Household products: 4.73% * Information services: 19.13% * Insurance (general): 6.26% * Investments and asset management: 21.06% * Office equipment and services: 4.91% * Publishing and newspapers: -1.64% * REIT: 15.17% * Real estate (development): 6.65% * Real estate (general and diversified): 19.75% * Real estate (operations and services): 3.59% * Recreation: 1.15% * Restaurants and dining: 10.57% * Retail (general): 2.44% * Retail (grocery and food): 1.44% * Retail (online): 4.57% * Shoe: 10.48% * Software (entertainment): 20.53% * Software (internet): 2.07% * Software (system and application): 19.54% * Transportation: 3.79%If you don’t see your industry above, check the full list on the U.S. Marginsby Sector page. You can also see the gross margin, operating margin, and otherstandard financial metrics for each sector.## Ways to improve your profit marginYou can increase profitability by raising revenue, reducing costs andexpenses, or doing a combination of the two. Here are some tips to achieveyour ideal profit margin: * Reduce your overall operating costs: These include office space and utilities, materials, supplies, wages and benefits, employee spending, insurance, equipment repair, shipping, and business software. Try to negotiate a lower rate, downgrade, or eliminate any unnecessary services. * Cut underperforming products or services, or add higher-margin products or services: A break-even analysis can help you figure out whether a product is truly profitable. You can draw inspiration from other companies in your sector or dive into the research on high-margin products for your industry. In any case, you’ll need to weigh the cost of goods sold and operating expenses against your desired selling price. * Adjust your pricing strategy: Experiment with different product pricing methods like value-based pricing or cost-plus pricing. You may be surprised by how product pricing impacts demand. * Build brand loyalty: Regularly engaging with your customers and showing customer appreciation has a tangible effect on sales and customer retention. Retaining more customers allows you to reduce your advertising costs.## What is a good profit margin?Profit margin signals a lot about a business. It’s a marker of yourprofitability, stability, and how attractive you are to investors. You canalso use it to understand how you compare with the competition, and evaluatewhether your business model is sustainable.But if you aren’t there right now, don’t worry. Use the strategies above andconsider contacting a financial advisor to receive one-on-one guidance.