I’m not going to bury the lead here … today I’m talking about profit margin.
Be honest: do you know what profit margin is + how to calculate it (without Googling)? Better yet...if you own a small business, do you know what your profit margin is? Don’t feel bad if the answer to those questions is “no”. If you don’t know what profit margin is, why it’s important, or don’t know what margin your business is operating at, I’m going to demystify all that and break it down step-by-step for you.
Side note: I was at a networking event last month with other local small business owners, and an accountant I met there told me a really humbling story. He had been working with established businesses for years, and MOST small business owners he met had no idea what profit margin was. And, they certainly weren’t tracking this number every month. Don’t feel bad if you fall in this camp -- it is super, super common.
How to calculate profit margin:
Profit Margin = (Sales - Expenses) / Sales
Easy, right!? Don’t overcomplicate this … there are fancy formulas out there for tracking this, and if you Google “how to calculate profit margin” right now, you will find complicated calculators and confusing accounting articles talking about revenue models, cost of goods sold, tax rates, etc. Ignore the confusing articles. Focus on the formula I just told you about:
Profit Margin = (Sales - Expenses) / Sales
If you’re bad at math like me, you might be wishing for an example right now, so I’ll break it down for you.
I own a lemonade stand. In April, I sold $100 worth of lemonade. Also in April, my costs were $30 to buy lemons, sugar, chalk for my lemonade stand sign, and cups. My profit margin formula looks like this:
Profit Margin = (100 - 30) / 100
In this example, my profit margin was .7 (or 70%). Easy, right!?
Homework Time!! Now it’s time for you to calculate your profit margin. Don’t worry … even if you’ve never done this before and are sort of scared about what you’ll find, this is going to be a really valuable exercise! Grab a cup of coffee and let’s do this...
- Step 1: Go download your bank statement from last month and get two different color highlighters.
- Step 2: For every line where you SPENT money, highlight with color #1.
- Step 3: For every line where you MADE money, highlight with color #2.
- Step 4: Add up everything highlighted in color #1 (this is your “expenses” number!)
- Step 5: Add up everything highlighted in color #2 (this is your “sales” or “income” number!)
- Step 6: Plug the two numbers from step 4 and step 5 into the handy formula I told you about:
YOUR PROFIT MARGIN = (Sales - Expenses) / Sales
That’s it! You just calculated your business’s profit margin.
With profit margin … bigger = better. A higher profit margin percentage means you make more money.
Want to grab the spreadsheet I use every month to calculate profit margin for my business? Sign up below and I'll e-mail you the spreadsheet right now!
If you do the exercise above, you’ll probably have one of these reactions:
- Wow, my margins are awesome! And I didn’t even know what profit margin was 30 minutes ago!
- Oh no….my number came out negative... (Spoiler: this was my reaction the first 3 months I did this exercise)
- Meh, that seems about right I guess
The first three months that I actively tracked my business’s profit margins, the number came out negative. That was pretty eye-opening for me, especially since we were doing upwards of $20,000 in sales for those three months! It was easy for me to forget how important something like profit margin is when I felt like we were making a lot of money. Boy, was I in for a wake-up call.
Once I realized our profit margins weren’t great (let’s be honest: they were bad), I could go into problem-solving mode.
Here are three immediate actions you can start taking once you’ve calculated your profit margin (I did all three):
- Set a goal for where you’d like your profit margin to be. If it helps, you can find industry averages for this all over the Internet. I linked to a great resource for this in a previous post, if you wanna go check that out.
- Break down your expenses into categories that make sense for your business, and figure out the top 1-2 expense categories to work on reducing (even if your margins are good, you can do this!)
- If there’s no practical way to reduce your expenses or if you’ve already trimmed them down and are happy with where they are at, think of one action you can take to improve your SALES … do you want to start marketing your business in a new way? Is there a new revenue stream you can add on to your offering? Do you need to start accepting more clients?
Finally...make a plan to spend an hour every month with your bank statements calculating this number. If you track this every month, you will start to notice patterns and be able to take targeted, meaningful action to improve your profitability and grow your business!
You got this!
Want to grab the spreadsheet I use to calculate profit margin every month? Sign up below and I'll e-mail you the download right now!
Now: what questions do you have on calculating your small business’s profit margin? Let’s talk about profitability + growth in the comments section!