Small businesses often strive for a high-profit margin, but what does this mean? What exactly is a profit margin and how is measuring it useful?
What is a profit margin?
A profit margin is the total difference between how much a business makes and the expenditures of said business. For a sole trader, this can be considered their earnings before income tax is applied.
Profit margins are flexible due to variable costs as well as variable income. As such, profit margins should always be accurately recorded.
Using profit margins
Profit margins can be used in a variety of ways throughout a business. Whilst many might believe it’s limited to predicting future financial gain, this isn’t the case. Profit margins are an excellent way to observe and display the development curve of a business.
A business’s performance can be measured directly by the profit margin. To do this, simply take the profit margin as a percentage total of all earnings, and compare that from month to month. If as the business expands, the percentage drops, then something needs to change.
By using the business performance measurements, you can present this as evidence of a growing business. Investors don’t want to invest in ideas and a common mistake is bringing an unrealised product to the table. In showing that not only do you care about the business but that the business works, you can more successfully attract funding.
Fixing a low profit margin
Low profit margins are scary, but they come and go. Being down 1% one month isn’t exactly a sign that the business is crumbling. However, there are signs that something is going wrong. The most major sign being that the overall income is not increasing yet the percentage profit margin is decreasing.
In order to fix a low profit magin, there are certain strategies you can employ:
- Raise the price of goods or services.
- Source materials or labor at a cheaper price.
- Try to cut out fixed costs (example: don’t pay for office space, work from home)