For your company to be successful, you must learn how to increase profits for your small business. Other than developing a good profit margin for small businesses, you should also strive to make sure your business is fully capitalized. By becoming fully capitalized and learning how to calculate profits for small businesses, you can encourage business growth and become more resilient. Whether you want to drive growth or navigate a downturn, your business will be better situated if it improves its profit margins.
What Is a Good Profit Margin for a Small Business?
Before you figure out how to calculate profit for small businesses, you first have to learn the answer to, “What is a good profit margin for a small business?” While the answer can vary based on your industry and your time in business, you generally want your gross profit margin to be higher than 7%. Anything lower than 7% indicates that you may be operating at a loss. If your profit margin is higher than 20%, then your business is incredibly profitable.
This amount can vary significantly from one industry to another. While the automobile industry has an average gross profit margin of 14%, the alcohol industry has an average profit margin of 38%. The profit margin for general retail organizations is 24%.
How to Calculate Profits for Small Businesses
Learning how to calculate profit for small businesses is important. The formula for profit margin changes based on whether you are looking at the gross profit margin or your net profit margin.
Gross Profit = (Revenue – Cost of Goods Sold) / Revenue x 100
Net Profit = (Revenue – Cost of Goods Sold – All Operating Expenses) / Revenue x 100
Net profit helps you understand the overall profitability of your business. Meanwhile, gross profits are useful for showing how your manufacturing and labor costs impact your profitability. The main difference between the two terms is that net profit subtracts operating expenses and the cost of goods sold from revenue, but gross profit only subtracts the cost of goods sold.
Calculating Your Labor Efficiency Ratio
You can find other ratios that can tell you how your business is doing. The labor efficiency ratio has always been an important calculation, but it is even more important when there is a tight labor market. As Baby Boomers begin to retire, the economy will continue to face a limited supply of workers. This means that small businesses need to understand their labor cost’s relationship to their profits.
Labor Efficiency Ratio = Gross Profit (minus benefits, employer benefits, and direct labor) ÷ Direct Labor Costs
Typically, a business should try to achieve a labor efficiency ratio that is higher than 2. Basically, this means you want to bring in $2 in profits for every $1 of labor costs. Because labor costs are the largest expense in the majority of industries, the labor efficiency ratio is an excellent indicator of how profitable and sustainable your company is.
How to Increase Profits for Small Businesses
After learning the answer to, “What is a good profit margin for small business owners?”, the next step is learning how to increase profits for your small business.
Pay Fair Wages to Get More Effective Workers
In a competitive labor market, it’s important to pay reasonable wages. As Greg Crabtree, partner at Carr, Riggs & Ingram mentioned in his recent podcast episode with Mission to Grow, you want to “pay a fair market wage because it then gives you the moral high ground to demand a fair market performance.”
Rethink Inefficient Managerial Staff
When considering each employee’s labor efficiency ratio, you should remember that managers should bring in around $8 per $1 of labor. They are higher-value employees, so they should be bringing in more money to the company. Often, high-paid managers will ask for raises to stay at an organization, but this means that many high-paid employees will eventually end up earning a wage that isn’t justified by the value they add to the company. While it’s important to pay workers fairly, there is a point when a high-paid employee’s wage doesn’t match their contributions.
Nourish Your Current Customer Relationships
While bringing in new customers is exciting, the average business will spend four to five times more acquiring a new client than they spend on retaining current customers. To find out how to increase profits for small businesses, you should start by nourishing your existing customer relationships. From upselling products to drip email campaigns, there are simple changes you can make to increase the number of sales you have to existing customers.
Invest in Advertising to Get New Clients
Many companies spend far less on advertising than they should. For instance, email marketing has a return on investment as high as $36 for every $1 spent. If you’re struggling to bring in revenue, you may want to revisit your marketing strategy.
What Does It Mean to Be Fully Capitalized?
If you want to find a good profit margin for small businesses, becoming fully capitalized can help. Becoming fully capitalized means developing cash reserves that can cover two months of your business expenses. Additionally, you will need to have nothing borrowed on your line of credit.
At the same time, you should work to get rid of your short-term debts by the end of each fiscal quarter. Short-term debt isn’t supposed to last forever, so you want to get rid of it every three months. In addition, you should make sure that you finish each year with no tax liability by the end of the year.
Being fully capitalized means your business is financially healthy and able to navigate sudden changes in the marketplace. It works in conjunction with building cash flow and a good profit margin for small businesses. By paying attention to these important statements and financial ratios, you can make sure your company is profitable and successful.
Learn More About Developing a Good Profit Margin for Small Businesses
What is a good profit margin for a small business? How can you build a good profit margin for a small business and become fully capitalized?
In order to make your business successful, you need to learn how to increase profits for small businesses. Over time, you can strive to make your company fully capitalized.