Successful business owners know the importance of understanding what is a good net profit margin for a small business. Once you know, you will better understand how to make the necessary changes to improve your small business’s financial health. For this reason alone, it should be as important as making a small business plan.

What is a profit margin?

Your net profit margin is the percentage of profit your business generates against the total revenue of your small business. The profit and loss statement of your business will make it easier for you to understand your net profit margin.

Once you know your net profit, you can divide it by the total revenue and then multiply it by 100 to get your net profit margin. Revenue is the total amount of money a company brings in from selling its goods or services at a specific price. For example, if you sell 500 units, each priced at £20, your total revenue is £10,000.

The net profit is what you’re left with after deducing the cost of goods sold (COGS) and operating costs. COGS is the total amount you pay for labour and materials to manufacture your product. Operating costs include the likes of rent, employee benefits, payroll, travel expenses etc.

In the above example, let’s assume that your COGS and operating expenses amount to £9,000. By deducting that from your total revenue, you arrive at a net profit of £1,000. So, your net profit margin would be £1,000 divided by £10,000 or 0.1. That, multiplied by 100, will give you your net profit margin, which in this case is 10 per cent.

How net profit margin differs for a new business

Conventional wisdom states that your net profit margin would be low when you start your business. This is due to low sales in the beginning. Once your sales go up, your revenue will be higher and so will be your net profit margin.

But this may not be the case forever. If your business grows quickly, you will need more employees, office space and infrastructure. These increases will increase your operating costs and decrease your profit margin.

6 tips to improve your profit margin

Now that you know what is a good net profit margin for a small business, here are six ways to improve it for your small business.

Review pricing: Increasing prices will increase your revenue. But find out how your competitors price their products before your increase the price of your products.
Reduce rent: Do you really need office space? Can at least some of your staff work remotely? If not, can you find a location that’s competitively priced? If you run a physical shop, is there an opportunity to move your business online?
Rationalise expenses: Whenever possible, avoid travel. If you’re using traditional landlines or mobile phones for business, consider getting an affordable second phone number.
Decrease interest payments: Do some research and you might find a loan with a lower rate of interest. By transferring your existing loans to these, you are likely to make significant savings.
Find cheaper vendors: You might find a vendor who would be able to supply products of the same quality at lower prices. Or you might find vendors with a wider variety of products.
Automate: You can use accounting or expense-tracking apps to save time and effort.

In short

Once you understand what is a good net profit margin for a small business, you’ll be on track to increase revenue, minimise expenses and maximise your profits.