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Small Business Profit Margin: What’s Considered Good, Bad and Average?

By Barb Weidner Reviewed By Ann Cornell
By Barb Weidner
By Barb Weidner Reviewed By Ann Cornell

Profit margins vary widely by industry, with some sectors such as alcohol and food service netting comparatively high margins. The average profit margin across all industries is 7.71%, according to a study by New York University

However, coming up with a target profit margin is a highly personalized process that must account for your business’s various characteristics and operating costs. Let’s go through the process to find out what the average profit margin is for your industry and location.

An arrow charts upward over growing piles of coins and gradually larger trees, symbolizing a growing profit margin.

What Is Profit Margin?

Your profit margin is what you earn in relation to your overall revenue. There are 2 types:

  • Net profit margin
  • Gross profit margin

Here are some of the main variables that can affect the profit margin of a small business:

  • Labor costs
  • Use of assets
  • Equipment maintenance
  • Inventory management
  • Cost control systems
  • Physical location
  • Tax and regulatory environment

What Is a Good Profit Margin?

A good profit margin falls between 5% and 10%, according to Brex, a financial services company. Note, however, there isn’t a single ideal profit margin for all businesses. 

Variations in the number of employees, skill levels, tax rates and scale all play into the average profit margin for your small business that you’ll pull in quarter after quarter. In some industries, the average small business profit margin hovers around 2% while other industries have quarters that exceed even 34%.

In addition to industry, there are 2 other top variables that influence a company’s profit margin:

Expansion

Take your expansion goals for your business into consideration when arriving at a target average profit margin. 

If you’re satisfied with your business’s current revenue, you don’t have to ramp up expenses or reinvest profits. For those who want a larger slice of the pie, aiming above 20% profit margins can make the difference between withstanding downward market fluctuations.

Scale

Account for scale when finding your small business’s target profit margin. Startups with few or no employees have fewer expenses and are, therefore, more likely to generate higher margins. 

By contrast, megacorporations with rent, payroll and employee benefits, such as Ford, Target and Walmart, bring in between 3.9% and 5.2% margins.

Also, overhead costs can make a big difference between a high and average profit-generating business. 

For example, independent consultants have virtually no overhead costs compared to a restaurant or nightclub owner who has to cover rent, payroll, inventory among other recurring expenses.

Average Profit Margin by Industry

No 2 profit margins will ever perfectly resemble each other at any time. What’s considered a good profit margin and an average profit margin for a small business depends on your industry, long-term growth goals and the overall state of the economy.

Lower Profit Margins

Hovering in the 2% range, lower profit margins are common in the grocery store, automobile dealership, lawn care and beverage manufacturing industries.

Higher Profit Margins

On the other end of the spectrum are industries such as dental care, car rental services and tax and accounting services, which consistently run net margins more than 20%.

Changes

The COVID-19 pandemic greatly disrupted the economic sector, causing even relatively stable average profit margins by industry to change in 2020 and 2021, according to Camino Financial. It could take years before gross and net profit margins return to pre-pandemic averages, Camino Financial notes.

A chart of profit margins by industry

Net Margin vs. Gross Margin

A net profit margin is the ratio of net income (i.e., income after expenses, depreciation, etc.) relative to revenue. Your gross profit margin is the amount of money you retain from product sales after subtracting the cost of goods sold (COGS)

Net margins, also known as net profit ratios, are always lower than gross profit ratios and operating profit ratios. As such, they are the best representation of your company’s financial health and overall efficiency because it considers all the overhead costs that went into the sale for a good or service.

Note that net profit ratios are only a portion of your company’s complete financial story. Heavy capital investment, research and development expenses and marketing expenses can drive down your net profit ratios even though they’re solid indicators of long-term growth. 

Don’t be tempted to buff up your net profit percentage by delaying certain discretionary expenses.

How Do You Calculate Profit Margin?

Similar to calculating your company’s operating cash flow (OCF), calculating profit margins involves a bit of simple division. Keep track of every expense, so you have an accurate figure of your sunk costs (right down to maintenance and transaction fees).

Although there are accounting tools available to help you find your margins, you can also quickly calculate it yourself using a pen and paper.

To find your gross profit margin, take the retail price of a product or service and subtract the cost of labor and materials that go into making it (COGS). When you have that figure, divide it by the retail price to find the gross profit margin. For instance, a $50 product that costs $40 to produce has a gross profit margin of 20%.

A sample gross profit margin formula

To find your net profit margin, which is used to determine the company’s overall profit margin, you need to subtract all expenses from revenues. Then, divide that sum by total revenues to find your net profit margin. For example, a business with $2 million in sales and $1 million in expenses would have a net margin of 50%.

A net profit margin sample formula

Tips for Improving Your Profit Margin

An image that lists tips to improve your profit margin

Cut Expenses

Asking “what is a good net profit margin” often shrouds the judgment of small business owners. Instead, a good profit margin can usually be generated by simply reducing overhead expenses wherever possible.

Improve Your Sales

You need to determine what is a good profit margin for a product or service and cut all those that fail to reach this predetermined threshold (i.e., cut your “loser” products). For instance, if you sell coffee at 50% margins but pastries at 5%, your pastry inventory may need to be cut back.

Pad Your Inventory

One of the most effective ways to bolster your small business’s profit margin is to wisely plan your inventory. Take the time to research your market so you can meet product demand without overstocking or suffering a shortage. It’s generally a good idea to slightly overestimate the supply of whichever products generate the highest product margin (i.e., your “winner” products).

Barb Weidner CEO at Fast Capital 360
Barb Weidner is the co-founder and CEO of Fast Capital 360, a leading online business loan marketplace. Prior to entering the Fintech space, Barb was the Chief Credit Officer for a mid-sized mortgage bank based in NY. Barb is passionate about simplifying the lives of small business owners and empowering them with the resources they need to thrive.
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