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What is a good profit margin?

Increasing your company’s net profit margin should be one of your main goals as a business owner. But when it’s time to start analyzing your profit margin, it’s essential to have a strong understanding of the average profit margin by industry. Otherwise, you won’t be able to accurately assess your company’s performance. Find out more about the meaning of a good net profit margin with our comprehensive guide.

Why is a good net profit margin necessary?

Your business’s profit margin must be as high as possible. The higher the margin, the healthier your profits, and the more confidence investors will have in how your business is being managed. Furthermore, having a good net profit margin can help you achieve financing – an important element of growth – more quickly. Knowing your company’s profit margin can also help you to identify and resolve issues, providing you with an opportunity to take advantage of efficiencies to save time and money.

How to calculate your company’s profit margin

There are two main types of profit margin: gross profit margin and net profit margin. Gross profit margin is the income that your business has left over after accounting for direct expenses, such as manufacturing costs and direct labor. Net profit margin is the income that your business has after all costs have been paid, including interest and taxes. For the most accurate insight into your company’s financial health, you’ll need to look at the net profit margin. Here’s the formula:

Net Profit Margin = ((Operating Profit – Interest – Tax) / Revenue) x 100

Average profit margin by industry

To a large extent, the meaning of a “good” net profit margin is dependent on your industry. According to a report from CBS, the following industries have the highest average net profit margins:

  • Accounting, tax preparation, bookkeeping, and payroll services (18.3%)

  • Legal services (17.4%)

  • Lessors of real estate (17.4%)

  • Outpatient care centers (15.9%)

  • Offices of real estate agents and brokers (14.8%)

If you look at these average profit margins by industry, you can see that they’re all service industries with minimal overheads. By contrast, car dealerships, construction, and oil/gas extraction are widely reported to have low profit margins, mainly because of the significant overheads that businesses in these industries need to deal with.

Ultimately, a good net profit margin isn’t just about how much money you’re making, but how your margins compare with other businesses in your industry. If you’re outperforming the industry benchmarks, you should consider your business to have a good profit margin ratio.

Good profit margin ratio: new businesses vs. mature businesses

It’s also important to remember that a good profit margin ratio is likely to mean different things for companies at different growth stages. Although it’s often assumed that new businesses and start-ups have to deal with lower profit margins, that may not be strictly true. In many cases, profit margins decrease as sales increase. This is because the increase in sales will accompany an increase in overheads, payroll, and other expenses. The fact that mature businesses may have more significant cash flows doesn’t necessarily mean that their profit margins are larger. 

How to improve your company’s profit margin

If your profit margin isn’t where it needs to be, there are several actions you can take. Firstly, try to decrease expenses by cutting the cost of your operations and slashing overheads. Automation can help you to eliminate inefficiencies and optimize your workforce. You should also think about reinvigorating your pricing strategy – for example, by using product bundling – or running an audit to determine which of your products/services aren’t performing as they should.

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