Once your business is established, it's important to figure out if it's doing as well as it ought to be. You would think figuring out your business’s ideal profit margin would be easy. But it’s not. Many variables go into figuring out profit-margin goals for a business – its size, location, the type of business you're in and other industry-specific factors.
What is the ideal profit margin? In 2013, a Reason-Rupe poll found that most people believed that businesses had a 36% margin, or $.36 profit on every dollar. Business owners everywhere probably laughed out loud when they read this, since, according to a Yahoo! Finance database for 212 different industries, the average margin is actually around 7.5%.
But the average is meaningless. Margins are industry specific. A grocery store might only see margins of about 3%, but a company that buys and sells real estate may make upwards of 30%. How do you know what your ideal margin should be if you’ve been in business for a while? Here's how to compute it.
There are two types of profit margins: net and gross. Gross profit margin is generally used to evaluate a single item. If you bought if for $X and sold it for $Y, your gross margin is the difference between X and Y. Multiply it by 100 and you have your gross profit margin expressed as a percentage, the standard way to report the figure. See What is the difference between gross margin and net margin?
Net profit margin takes into account everything: operating expenses such as debt payments, investment income, one-time payments, taxes, cost of goods sold, utilities, employee expenses and general overhead items. This is the measure that businesses use to report their profitability. For publicly traded companies, it’s expressed as the “bottom line.”
When you’re reading industry data on profit margin, make sure you know which type is being discussed. Most firms report net profit margin. But it can be useful to know How is gross profit margin used in sales?, as well.
Here are some other sources for putting your finger on that magic margin number.
1. Industry Data
You can’t compare your profit margin to that of a buddy who operates in a different industry. Net margins are wildly different in various economic sectors. You can only compare yourself to your industry peers.
You’re probably a member of your industry’s trade group. That’s the best place to find your ideal profit margin. If you can’t find it on a website, call and ask for a report that has that information. Associations often have data for different size companies and subsectors of your industry. If you want to set a benchmark for yourself, that’s the place to start.
Additionally, if you’re not yet a business owner and evaluating a few different business opportunities, call the industry trade groups of each and ask about profit margins. If you’re going to pour your life into a business, you might as well earn as much money as possible doing it.
Although industry-specific information is most important, the general data in various online resources can provide useful context (especially If you are still in shopping-around mode). There are numerous comparative sources available, including one from the aforementioned Yahoo! Finance, and one from New York University’s Stern School of Business. Be careful with these resources, though. Yahoo! Finance’s list evaluates public companies using their publicly reported data. These companies are likely larger than yours, and their numbers could include any number of accounting caveats – a one-time charge-off, for example. See A Look At Corporate Profit Margins.
You do attend your industry's major annual conference, right? Link up with other business owners in your industry to exchange information. People operating businesses like yours on the other side of the country probably aren’t too concerned about divulging their margins since you’re not direct competitors (unless your business is largely online, of course). Ask them about their margins and how they keep costs down. You might even get the name of a vendor with lower prices.
Speaking of vendors: If you really want to talk to people with their fingers on the pulse of your industry, talk to them. They know what others in your business are doing and what their numbers look like. And if they don’t have the answers you’re looking for, they can tell you whom to ask. Might as well tap in to their bank of information.
The Bottom Line
The best place to find accurate profit-margin statistics is to contact your industry group. It will have detailed statistics for your specific business type. And make it a habit to keep on checking and comparing. Changing economics and factors of supply and demand constantly affect profit margins. Companies are constantly looking at their growth and how to manage it without losing profitability.
Finally, don’t forget that “average” net margins aren’t what you should strive for. You never want to be average in anything your business does – do you?