A key affirmation of small business performance is profit margin. This measure unlocks widespread understanding of whether a venture is on a trajectory of success or moving into a setting sun of disappointment. Shaping a complete business strategy begins with profit margin oversight. The metric reveals trends with input costs and the adequacy of your prices.
The root cause of profitability is profit margin. Net profit – the most commonly understood measure of profitability – is simply determined by subtracting all business expenses from business sales. The net profit margin is then the profit as percentage of sales. Divide net profit by sales; multiply by 100 to attain the percentage.
It’s All Relative
Depending on your industry, net profit margin might be 2 percent or it could be 20 percent. Finding the average net profit margin for your type of business requires some research on the internet. But figures are generally available from studies conducted by a number of institutional sources, thus permitting you to see how you measure up within your field.
The main ingredient to scrutinize is your operation’s profit margin in the most recent period compared to earlier periods. A rising margin is clearly a signal victory. Conversely, a declining margin calls for constructive solutions to stop the deterioration.
Impact of Gross Profit
Before jumping to conclusions about net profit margin, first examine gross profit margin. Gross profit is business revenue minus direct costs of the sales. A retail store calculates gross profit by subtracting the cost of items sold from the revenue obtained when selling them. Dividing gross profit by revenue results in the gross profit margin percentage. But even a business providing services can determine a type of gross profit. This is an exercise in identifying the direct costs that vary with revenue.
If you sell various products or services, evaluate the gross profit margin for each category. If some of the things you sell incur lower gross margin than others, your resources are likely better spent by focusing on the most profitable areas. For example, services that demand a lot of travel expense might be pruned from your business offerings. This would permit doing more of the less costly work that you conduct online.
Components of Net Profit
After conquering the summit of understanding with gross profit margin, it’s time to complete your analysis with a careful decent into operating expenses. Net profit margin considers all expenses, including general overhead costs that are not directly connected to revenue generation. If gross profit margin is steady but net profit margin is declining, overhead operating expenses are the culprits.
Calculate the percentage of expenditure categories relative to revenue. Start with the largest expenses. For many small businesses, these targets are rent and labor costs. After identifying the types of expenses that are changing most when compared to revenue, you can decide if action is required. Non-recurring events can cause temporary spikes in operating expenses, which lowers net profit margin. But a permanent increase in an overhead cost represents an ongoing cut in profitability. Adjusting an operating expense is generally the easiest method for restoring net profit margin.
The Finance Writer 