When you are setting up a new venture, or expanding your business, isn’t funding the primary lifeline?
“Of course”, says Jon Doe.
What is a Profit Margin?
For businessmen and entrepreneurs aiming to make it big, the word profit, and its maximization, are of immense significance. Simply put, a profit margin is the ratio of net income divided by revenue, or net profit divided by sales. Some sectors work with higher profit margins, while others have less.
“It varies greatly across industries and markets” says Jon Doe.
Here are some useful tips to help new entrepreneurs analyze the meaning of “acceptable profit margin”.
How Much of a Profit Margin is Ideal?
First, Calculate Gross and Net Profits
If you sell a product for $100 that has been purchased for $80, gross profit is 25%. Calculating simple net profit can be achieved in this way. Let’s say Jon Doe has a business that yields him $100,000 in revenues per quarter. To achieve the Net Profit calculation, Doe has to calculate total business expenses such as rent, electricity, employee’s salary, etc. Now let’s say for example that the total of all these items is $75,000. Then by this calculation, Doe has made a quarterly net profit of 33%. So, the net profit is more crucial for your business than the gross profit.
Profit Margins Vary Across Business Sectors
“A simple yet so important element for a new business owner to track” says Jon Doe.
While real estate firms may have profit margins as high as 18%, grocery store margins are traditionally much lower…perhaps as low as 2%. Despite the high margin disparity, both business sectors produce sustainable businesses with overall failures on the low side.
That being said says Jared J. Davis,
“the owner of a new or expanding business should always ask himself the crucial question…which is…are you more comfortable owning a business with more risk and then more to gain, or less risk with more reliability”?
New vs. Mature
This is another very crucial aspect that should always guide profit margin expectations. Jon Doe says
“a newly formed business will on average return less in its initial stage of growth. However, as business increases, its foothold in the marketplace should produce increased sales, profitability, and brand value. Increased profit margins are sure to follow”
Compare the above scenario to another industry, let’s say minerals and mining. Starting a business such as this demands a large investment, takes years to ramp up, and even more, time to start turning a profit. However, when profits start to accrue, the numbers are larger…going into the millions Thus, the nature of investment and industry also significantly impacts profit margins and expectations.