Money isn’t everything – except when you’re a new business. For startup organizations earning capital is a top priority. You can tell investors and bank managers that you’re the next Jeff Bezos. However, they won’t take serious action until hearing about your financials, specifically profit margin.
Net Margin vs. Gross Margin
There are various types of profit margins. However, the two most commonly measured for new businesses are net margin and gross margin.
Gross profit margin
Gross profit margin calculates the profitability of a single product or service. For example, let’s say you sell water bottles for $25. The water bottle costs you $10 to make. Therefore, your gross profit margin would be 60%.
While gross profit margin is a good metric to measure over time, most investors ignore it when evaluating your business’s potential success.
Net profit margin
On the contrary, the net profit margin identifies your startup’s profitability as a whole – not just a single product. It is the metric lenders are most interested in learning when they ask, “Is your company profitable?”
Let’s take a closer look at how to calculate net profit margin in the next section.
How to Calculate Net Profit Margin
Net profit margin is calculated by dividing your net profits by net sales and multiplying that number by 100. It is a critical metric for determining the profitability of a new business because it looks at total sales, minus all business expenses, and divides that figure by total revenue.
For example, if your startup organization earned $200,000 last year and had $150,000 worth of expenses, your net profit margin is 25%.
Mathematically, $200,000 (net profits) – $150,000 (cost of goods) / $200,000 (net profits) X 100 = a 25% profit margin.
Understanding how to accurately measure this metric allows you to optimize your margins. The benefit? The higher your profit margins are, the more money you’ll make as an entrepreneur and business owner.
What is a Good Profit Margin?
So, the question of the hour: what is considered a good profit margin for a startup business? Unfortunately, this might not be the answer you’re looking for, but it truly depends. Because every business is different, various factors define what an ideal profit margin should be.
The most determining component is the industry your business is in. For instance, let’s say you own a local flower shop. You design some of the most beautiful wedding centerpieces in town. As the year is winding down, you turn to your records to see a net profit margin of 32%.
In the same scenario, your cousin owns a marketing automation company. The firm sells software that automatically manages different marketing processes. The company’s net profit margin is 22%. Although your net profit margin is 10% higher, it does not necessarily mean your flower shop is making more money.
While profit margins might gauge the success of your organization, the metric has zero impact on your overall earning potential. Profit margins are specific to each business sector due to the economic factors of each industry. As a result, it is difficult to blindly say what percentage is a “good” profit margin.
Profit Margins by Industry
Don’t go anywhere just yet! We may have the answer you’re looking for after all. There are general guidelines startups can follow to better understand where their profit margin compares to the industry standard. Don’t see your industry listed? For the full table, click here.
Strategies to Grow Your Profit Margin
Although profit margins do not determine the overall success of a company, the higher your margins are, the better.
I know that’s an easy equation to follow.
Here are a few tips to increase cash flow and grow your net profit margin.
Determine where you can reduce spending.
Take a closer look at your monthly payments. Are you paying too much for your internet service? Do you actually use LinkedIn Premium features? Chances are you will identify some unnecessary expenses that are impacting your margins.
Restructure your pricing model.
One of the most significant ways for new businesses to increase their net profit margin is to stop underpricing their products and services.
Although the cost of doing business seems to rise each year, small business owners are afraid to raise their prices. They believe customers will leave for a competitor in fear of being price gouged.
Rest assured, most customers will pay more for quality products and excellent customer service. Which leads me to my next point…
Focus on improving customer retention.
Did you know, a 5% increase in customer retention can produce 25% more profit. Plus, organizations that excel at a positive customer experience drive revenues 4% to 8% higher than those of their market.
Instead of focusing all resources, time, and energy on acquiring new prospects, remember that keeping existing customers is equally if not more important for good profit margins.