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Running a startup isn’t easy, but calculating your profit margin doesn’t have to be something that keeps you up at night.
In fact, it’s pretty simple to calculate your profit margin and to figure out how you and your team can improve it.
What is a profit margin?
The simple, textbook definition is: “The profit margin is a ratio of a company’s profit (sales minus all expenses) divided by its revenue.”
Understanding a profit margin is pretty straightforward, and can help you determine how profitable your business is.
To put it simply, it allows you to analyze the health of your business’s income.
Think of your profit margin as the center hub of your business. It gives you insight into what your business is doing well and where it can improve. Maintaining a good profit margin is important to your business, future employees, and potential investors.
How to calculate your profit margin?
The most common way to calculate the profit margin of your startup is by using the following formula:
The profit margin formula is net income divided by net sales. Net sales are gross sales minus discounts, returns, and allowances. Net income is the total revenue minus expenses. To get the most accurate understanding of your profit margin, it’s important to itemize your business expenses as clearly as possible.
A 10% margin is considered average and is a good place to strive for as a startup.
Those of you that are visual learners will appreciate this breakdown of calculating a profit margin.
Why profit margin is so important?
Profit margin is used to measure the vitality of your business. Understanding the profitability of your business is essential as it helps you to understand how to make adjustments where needed.
For example, averaging your margin would allow you to see if operational costs are too high. It also allows important decisions to be made such as how and when additional employees can be hired or whether or not a storefront or eCommerce platform would be best for your business.
Profit margins are also an important factor for potential investors. In case it’s below the industry average, that can be a negative sign for the potential investors. They want to see a business that has its head above water and is making progress. Another advantage of understanding your profit margin is the ability to spot any potential fraudulent activity in your business. Keeping any loss–intentional or not–at bay as a startup is vital.
How to increase your profit margin?
If you have already calculated your current profit margin and are disappointed with the results, there is hope!
There are some very simple things that you and your team can do to increase your profit margin. Try to see this as an opportunity for some critical thinking and problem-solving.
One thing that’s important to remember is that as a startup, you’re meant to constantly grow. The keyword there is growing, which means that not having the profit margin you want in the early stages of a business is relatively common, and nothing to be stressed about.
That said, here are some proven actions you can take to grow the profit margin of your startup.
Cut unnecessary expenses
You most likely have a personal budget for your household, and understand that what you bring home in your check isn’t what stays in your checking account. What did you do when you faced a setback in your personal finances? You most likely cut out any unnecessary expenses such as going out to eat or frivolous spending.
The same should be true of your startup.
Analyze your expenses and see if there are any areas that you can trim. This might require you to get creative and seek alternative tools and resources that may be a bit more budget-friendly, or seeing if you can optimize your assets as best as you can.
This might also mean that you may need to lower your expectations for some time. The pristine and optimistic version of your business is certainly your endgame, but it shouldn’t be your immediate goal.
Cutting down on the aesthetic costs of your startup may mean that you get to hire someone to handle the aesthetic for you in the future.
Small sacrifices now mean a better profit in the future.
Lower the cost of necessary expenses
Of course a brick and mortar business is going to need things like a security system, insurance, and utilities. But the more you take time to shop around for the necessary for your business, the more you can sniff out the most cost-effective options as well.
Lowering costs, even by a just small fraction, really does add up. This lowers your overall operating costs, which increases your profit margin.
Focus on customer retention
You likely know that winning over new customers is much more expensive than maintaining existing ones. Depending on what your profit margin looks like, begin to offer incentives for existing and loyal customers.
This is an opportunity to be creative in your customer retainment strategies. It is also an opportunity to be intentional with customers, and show them how much you appreciate them. Spending a little on your existing customers now has been proven to be incredibly lucrative for the future (more sales from loyal customers equals a larger profit margin).
We mentioned juicing your assets as best as you can. This essentially means using any and all existing supplies that you have before purchasing more. Sure, the poly mailers that you’ve found online are on brand and affordable, but the pack of 500 sitting in your stockroom needs to be used. One popular gaping hole in a profit margin is the unwillingness to use goods and services that are already available to the business.
Offering competitive prices is great in theory, but not in reality if it isn’t something that your business can afford. Remember, the product isn’t the only thing that you need to see a return on. Your operating expenses also take a large portion of your profit. Don’t let the intimidation of raising prices deter you from the possibility of improving your profits. Plus, if you effectively brand your startup as a higher-quality, higher-price, and go after the right customers, you’ll have no problem pushing products or services. It’s all about marketing.
Use inventory systems
If you sell products, then easily one of your biggest expenses will be your inventory.
Whether you produce your own or purchase from a vendor, your inventory is likely a key player in your profit margin. To better manage your inventory, you should use an inventory management system. It can help you know how much inventory you have at all times and also prevent overstocking or understocking.
The most important benefit of an inventory management system is that it can minimize inventory loss, and streamline the entire inventory process.
Profit margin: Key takeaways
Your profit margin is the heart of your business and anything worth doing is worth doing well.
Not only does it reveals a lot about your business and best practices, but it can act as the best conscious for your business decisions. Small changes can really make a great difference in your startup’s profits. Owning and maintaining your business isn’t a sprint. The areas you want to invest more in your business will get the attention they deserve when the finances align. In the early years, it’s important to get a hold on your business finances, plan carefully, and remain determined.
Remember, your profit margin isn’t hard to calculate and it’s not difficult to improve. Your startup venture is an exciting time for you and you are fully capable of turning your vision into a business that thrives.
Sometimes we all need a bit of help being told we can do difficult things. What is even better is when we are told how we can do difficult things. That’s the whole vision behind IdeaBuddy. Our Financial Plan feature allows you to easily calculate profit and cash flow, even if you’re not finance-savvy.
In fact, IdeaBuddy is your complete toolkit in helping you map out your startup, as well as providing a safe space where you can brainstorm ways that you can increase your profit margin.