The purpose of a business is to create profit, and profit is income minus expenses and what’s left is profit.

Income is vital in business; however, income means nothing if you don’t make a profit.

Profit margins are essential key performance indicators (KPIs) to track in your business. As your business grows and your income grows, your profit margins should stay tight or increase, and if they decline, that’s a red flag.

Business owners need to know the profit margins of their business. You need to know the overall operating profit margin and the net profit margin and profit margin for each product and service you offer. This way, you will know which product is the most profitable and makes the most money for the company.

What is a profit margin?

A profit margin measures the performance of the business and how well the expenses for earning more measure up. The higher the profit margin, the more successful the business is in keeping costs down to generate revenue.

What are the different types of profit margins?

There are three types of profit margins that you can find in your business:

1. Gross profit margin – this is the margin that is used to measure net sales less cost of goods sold.

2. Operating profit margin – also known as EBIT (earnings before interest and taxes), represents the efficiency with which a business can generate profit from its core businesses.

3. Net Profit Margin – is an important ratio that measures net income generated as a percentage of income received.

How to calculate profit margins?

Profit margins are key performance indicators (KPIs) that show you how the business is performing. Higher profit margins help prove the financial health of the business.

Gross profit margin = (cost of goods sold / revenue) x 100

Operating profit margin (EBIT) = (net profit before interest and taxes / income) x 100

Net profit margin = (net income / turnover) x 100

What should my profit margins be?

A frequently asked question and the answer depends on the industry of your business.

Restaurant industries are noticeably weaker and can average 3-9%. Professional coaching services have higher profit margins, and an average profit margin of 20% is considered good across industries.

However, if you can have a higher profit margin in your business than industry standards dictate, consider that an amazing thing and aim for it. The higher your profit margins, the more profit you will keep in your business.

Profit margins are important because they are beneficial for the overall profitability of your business.

How can I improve my profit margins?

There are several ways to improve your profit margins. When you pay attention to your pricing strategies and make sure they align with profits, you will increase your bottom line.

When you reduce the cost of goods sold and operating expenses, you increase your profit margins. Expenses eat away at the profit margin. Therefore, if there are ways to reduce your costs, such as bulk orders, lower production costs, reduced product defects, these changes can lead to a significant increase in your margins.

There are many KPIs to measure in a business, and profit margins are of the utmost importance. When you monitor your profit margins monthly or more frequently, it helps identify fluctuating trends and reduce money leaks before they become problems.

Ultimately, you want to make your business as profitable as possible. Tracking your profit margins and squeezing spending to increase your profit margins can benefit your bottom line.