Your Business: What Your Profit Margins are Telling You

Written by Charlotte Steel 

Your profit margins are powerful indicators of your business’s health and efficiency. They reveal how effectively you’re converting revenue into actual profit, guiding your decisions on pricing, cost control and growth. This article will explore why healthy profit margins are essential and show you how to calculate gross and net profit margins so you can determine where your business stands financially.

The Importance of Healthy Profit Margins

A healthy profit margin indicates resilience and operational effectiveness, especially critical for SMEs and Start-ups. Good margins mean your business can withstand cost increases, adjust to market demand shifts and reinvest in growth. Understanding what your margin says about your business empowers you to make targeted adjustments that maintain long-term profitability and sustainability.

Explore your Profit status

1. Calculate Gross Profit Margin

Gross profit margin shows how much of your revenue remains after covering the Cost of Goods Sold (COGS) - your materials and subcontractor costs, highlighting the profitability of your core operations. Here’s the formula:

Gross Profit Margin = (Revenue - COGS) / Revenue x 100

For example, if your revenue is £50,000 and your COGS is £30,000:

• Gross Profit = £50,000 - £30,000 = £20,000
• Gross Profit Margin = (£20,000 / £50,000) x 100 = 40%

A higher gross profit margin means your products or services cover production costs effectively. If your margin is low, it might be time to consider adjusting pricing, reducing production costs, or re-evaluating suppliers.

2. Calculate Net Profit Margin

Net profit margin offers a complete view by factoring in all business expenses, not just COGS. It includes administrative costs, salaries, taxes and interest. 

Here’s how to calculate it:

Net Profit Margin = (Net Income (after all expenses paid) / Revenue) x 100

Using the example above, if your total expenses (including COGS) are £45,000, your net income is £5,000:

• Net Profit Margin = (£5,000 / £50,000) x 100 = 10%

This metric shows how much profit remains after all expenses, giving you insight into overall efficiency. A low net profit margin can indicate areas for potential savings or improvements.

TIP: I always share with my clients to never go below 10% net profit, unless you have budgeted for a temporary dip. This could be because you’ve appointed a new employee to join your growing business and have budgeted for a 3 month settling in period, as an example. 

3. Regularly Monitor Margins

Keeping margins healthy requires regular tracking. Monitoring your margins month-over-month or year-over-year can reveal trends and alert you to issues early. Comparing your profit margins with industry benchmarks also helps you gauge your performance and uncover opportunities for improvement.

4. Make Margin-Driven Adjustments

If margins are tight, take immediate action. Consider revisiting pricing strategies, negotiating with suppliers, cutting non-essential costs, or enhancing operational efficiencies. Prioritise actions that protect profitability without compromising the quality or value of your offerings.

Focus on your metrics

Your profit margin is the pulse of your business. Calculate and monitor your gross and net profit margins regularly to understand where you stand financially. Focus on improving these key metrics to strengthen your bottom line and build resilience. Start today by reviewing your profit margins and taking steps to enhance your business’s profitability and sustainability.

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