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Your profit margin tells a story about your business’ health. Here’s how to work it out – and avoid common mistakes.

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Whether you’re Amazon, Alibaba, or running an organic skincare business from your home office, you need to be clear about your profit margin at all times because it’s a fundamental indicator of business performance.

<h2>What is profit margin?</h2>Profit margin is the percentage of every dollar you keep from each sale.&nbsp;As <a href="https://www.myob.com/au" rel="noopener noreferrer" target="_blank">MYOB</a> CFO Caroline Rawlinson explains, “Profit margin is calculated by dividing your business’ net income by your revenue, then multiplying by 100.”So, in other words, if your revenue was $100,000 and the cost of your product was $70,000, then your gross profit margin would be 30 percent.&nbsp;

<h2>Why profit margin matters</h2>Getting into the habit of regularly checking in on your profit margin enables you to:<ul><li>Keep your expenses and returns visible at all times so you can spot issues such as pricing and cash flow before they become problems.</li><li>Decide if you can afford to invest in growth activities such as innovation, research and development or new hires.&nbsp;</li><li>Be clear about whether your business is making a profit, breaking even, or in danger of closing down.</li></ul>“Important investment and operational decisions should be made based on profit margins, so ensuring it is accurately calculated is vital,” Rawlinson advises.&nbsp;

<h2>How do you monitor your profit margin?</h2>Producing a monthly profit and loss statement (a “P&amp;L”) is a key part of monitoring profit margins.&nbsp;Most modern accounting software packages can do this for you and are relatively inexpensive and easy to use. Or you can visit the <a href="https://ascent.sba.gov/2a/a6/83cfbd2149a882a791f18f5cd2e6/your-business-financial-strategy-2-1-financial-statements-business-growth-decisions-tool.pdf" rel="noopener noreferrer" target="_blank">U.S. Small Business Administration</a> to download a template and create your own.“Take time each day to keep your records up to date so your profit and loss statement is accurate. Think about it as your daily banking – an essential administration task that must be done,” says Richard Harling, a senior retail consultant at Retail Life.&nbsp;

<h2>What is a good profit margin?&nbsp;</h2>In short, it depends on your industry.<a href="https://corp.vendcdn.com/Vend-Files/Vends-Retail-Benchmarks-Guide-2019.pdf" rel="noopener noreferrer" target="_blank">Vend</a> reports that the average North American retailers’ gross profit margin (their profit margin before expenses) was 53.5 percent in 2019. However, net profit margins for U.S. retailers generally sit b<a href="http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html" rel="noopener noreferrer" target="_blank">elow 10 percent</a>. Some U.S. industries have much higher margins; <a href="http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html" rel="noopener noreferrer" target="_blank">alcoholic beverages</a> can command net profit margins of more than 20 percent, while <a href="http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/margin.html" rel="noopener noreferrer" target="_blank">healthcare technology businesses</a> deliver around 13 percent net profit margins.To find out how your profit margin is tracking against your competition, it’s helpful to find out your industry benchmark. A good place to start is with the <a href="https://www.census.gov/programs-surveys/surveys-programs.html" rel="noopener noreferrer" target="_blank">U.S. Census Bureau</a>.&nbsp;

<h2>Want to improve your profit margin?</h2>Read Afterpay Access stories about how to boost your business’ profitability and the three money mistakes small businesses often make.And lastly, don’t make these four mistakes when it comes to calculating your profit margin...Not having a full picture of where your money is going “The most common mistake – especially for anyone new to business financials – is not including items such as depreciation and interest in expenses. This makes profit artificially high,” Rawlinson points out.&nbsp;Not paying yourself a wage “Some owners don’t cost their own labor, but you have to include this when calculating your overall business expenses,” Rawlinson says.Incorrectly pricing goods and services “Knowing your profit margins will help you clarify what margins to place on your goods and services so you make a profit,” Harling states.Lack of processes “When a business is starting out there is often a misconception that setting up proper accounting or business systems isn’t worth the time, cost or effort, but doing so is a great way to set it up for long-term success,” Rawlinson adds.&nbsp;

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All references to any registered trademarks are the property of their respective owners. Afterpay does not endorse or recommend any one particular supplier and the information provided is for educational purposes only. The information in this article is general information only.&nbsp;It should not be taken as constituting professional advice.&nbsp;Afterpay is not a financial advisor.&nbsp;You should consider seeking independent legal, financial, taxation or other advice to check how the article information relates to your unique circumstances. Afterpay is not liable for any loss causes, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly by use of this article.&nbsp;

Your profit margin tells a story about your business’ health. Here’s how to work it out – and avoid common mistakes.

Your profit margin tells a story about your business’ health. Here’s how to work it out – and avoid common mistakes

Profit margin - how to calculate it and why it's important

How to calculate profit margin - and why it’s important

Experts share the financial traps they see entrepreneurs and business owners fall into, time and again

With <a href="https://www.fundera.com/blog/what-percentage-of-small-businesses-fail?irclickid=2TWwtCSYNxyLTA6SPQQBEz9fUkBR8iVRUw4tUM0&amp;irgwc=1%3Fcampaign%3D10078&amp;source=Fundera_Impact&amp;utm_campaign=Skimbit%20Ltd._10078&amp;utm_content=Online%20Tracking%20Link&amp;utm_medium=affiliate&amp;utm_source=Impact" rel="noopener noreferrer" target="_blank">50 percent</a> of small businesses closing within the first five years, we’ve explored three common money mistakes so you can stay on the path to growth.

<h2>Mistake 1: Cutting costs rather than increasing revenue</h2>As the saying goes, it costs money to make money, and there’s a finite limit to which expenses can be cut.So, rather than cutting costs, business owners should consider how to grow revenue.<a href="https://www.alanmanly.com.au/" rel="noopener noreferrer" target="_blank">Alan Manly, an entrepreneur, company director and author of The Unlikely Entrepreneur</a>, says that business owners need to figure out how they will manage cash flow and where their revenue will come from, early on. While retaining customers is crucial, business owners also need to focus on new prospects.&nbsp;

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“Sometimes small businesses give more service than was required, which takes you away from serving the next customer.”

“I’ve seen small businesses bend over backward to serve their customers, giving more service than was required, which takes you away from serving the next customer.”Rather than reducing costs, Manly recommends:<ul><li>Increasing the number of customers that you’re trying to bring in the door.</li><li>Increasing the average transaction size by upselling.</li><li>Increasing the frequency of transactions per customer.</li></ul>Manly adds that hiring an accountant or bookkeeper can bring phenomenal value to a business, he says. “Having access to actual cash flow can be priceless, because it means you can make quick decisions.”

<h2>Mistake 2: Mixing business and personal finances&nbsp;</h2>Failing to separate business and personal finances remains one of the biggest mistakes that small business owners make, experts agree. While it might seem tempting to make personal purchases from your business account or vice versa, failing to keep accounts separate will make the financial reconciliation process complicated at tax time – which can lead to higher accountants’ fees.Financial separation can also be important when trying to secure a business loan – as banking institutions will need a true picture of financial turnover – and it can also offer tax benefits and the ability to shield your personal assets in case the business fails.

“The mistake many make is seeing the business as theirs and therefore any income as theirs.”

Scott Harrington, a director at <a href="https://williambuck.com/" rel="noopener noreferrer" target="_blank">William Buck Accountants &amp; Advisors</a>, has helped hundreds of businesses with their financial affairs. “The mistake many make is seeing the business as theirs and therefore any income as theirs. But the income needs to be offset for many reasons, including tax minimization,” Harrington says.It's a similarly common mistake for business owners to underpay themselves. "You'd be amazed at how many business owners work for their staff rather than the other way around," says Sandy Chong, the CEO of the <a href="https://www.theahc.org.au/" rel="noopener noreferrer" target="_blank">Australian Hairdressing Council</a> and a director of the <a href="https://www.cosboa.org.au/" rel="noopener noreferrer" target="_blank">Council of Small Business Organisations Australia</a>. "A lot of small business owners would own less than their staff."

<h2>Mistake 3: Not having a backup funding plan</h2>Cash flow is vital for small businesses, and Harrington says that it’s important that business owners know where they can turn for funding during lower trading periods.He recommends that businesses set up a separate savings account, which can be used as an emergency fund if needed. Start by putting money into your emergency fund as soon as cash rolls into your business bank account. This will allow you to survive slow periods and will keep you one step ahead.Many accountants recommend that your emergency fund should cover three to six months of operating costs, depending on the business type and the potential for revenue fluctuations.And while that might not be realistic for some businesses – especially in fashion, where long production cycles can tie up cash for months – even having a little up your sleeve to get you through the inevitable peaks and valleys of business will help, Harrington says.Setting up an automatic transfer that sweeps money into a separate account each time your business receives revenue is a great way to get into the habit.

“Identify what parts of your business can be switched off if revenues dry up.”

Harrington adds that a seasonally adjusted cash-flow forecast can be a valuable roadmap for any business.“It can also be valuable to identify what can be switched off in your business for a period of time if revenues dry up,” he says. “This was a valuable lesson for many during COVID-19.”&nbsp;

All references to any registered trademarks are the property of their respective owners. Afterpay does not endorse or recommend any one particular supplier and the information provided is for educational purposes only. The information in this article is general information only.&nbsp;It should not be taken as constituting professional advice. Afterpay is not a financial advisor. You should consider seeking independent legal, financial, taxation or other advice to check how the article information relates to your unique circumstances. Afterpay is not liable for any loss causes, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly by use of this article.

Experts share the financial traps they see entrepreneurs and business owners fall into, time and again.