Small businesses are always looking for ways to increase revenue. Whether by increasing sales, eliminating redundancies or decreasing internal expenses, organizations are on the lookout for the next big cost-saving measure that will free up valuable cash flow.
What many small businesses may never calculate, however, is their business’ profit margin, an essential figure for anyone trying to find ways to increase the bottom line. A company’s profit margin is the easiest and quickest way to tell how efficiently a company uses its resources, and it’s a great tool to gauge a company’s profitability.
What Is a Profit Margin?
Profit margin is defined as a ratio of profits earned to total costs over a defined period (e.g. a quarter, a year, etc.). Each industry generally has its own average profit margin due to the differences in costs and materials needed for different products and services.
There are two types of profit margin that small businesses might find useful:
- Gross Profit Margin: The gross profit margin equation is typically used to determine the profit margin of a singular product or service, not of an organization as a whole. To determine the gross profit margin, a business looks at the retail price of its product and subtracts the cost of materials and labor used to produce it. It then divides that by the retail price. For example, if you sell a product for $25, and it costs $20 to make, the gross profit margin is 20% ($5 divided by $25).
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