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The Real Key to Abundance

business growth female financial empowerment finance Apr 30, 2024
Lucy Starbuck

Welcome back to the world of financial empowerment, where we dive into the depths of business numbers with a touch of femininity and a dash of fun.

In case you don't already know me, I'm Lucy Starbuck, your guide through the world of small business finance. I'm all about empowering female entrepreneurs (like you) to thrive in the world of business.

In this article, we're going to talk about the different types of profit margins for your business. Before I lose you out of boredom, I really want everyone to understand how important it is to know what your profit margins are because they are the real keys to abundance.

So often this is missed, especially in small businesses, because there is a misconception that if you've got cash in the bank, you're good. The truth is that delving into your numbers, understanding what your profit margins are, and knowing how to make them bigger is the real flex in business.

What is a "Profit Margin?"

Put simply, your profit margin is measured by how efficient your business is at making money. While there are three types of profit margins which I'll get into in a moment, I want to make clear that the health of your business depends on a) making sure it's really obvious where your income comes from, b) it's clear where your expenses are going, and c) that your business isn't weighed down by too many of those expenses. All of these things are based on our profit margins. My aim in business is to get you making more money for doing the same amount of work, or less. In saying that, it's not all about how much cash you bring in, but about how that revenue stacks up to everything else in your business.

Understanding Efficiency

When I talk about efficiency, what I'm really talking about is how efficient you are at generating a profit from the revenue that your business is bringing in. This is where our wonderful profit margins come in, because they give us an actual measurement that is fact-based as to how our business is performing. The profit margin is a percentage number, so we can see how much profit we've generated as a percentage of the revenue that we brought in. The higher the percentage is, the more efficient your business is.

A common mistake I see is people thinking because they've doubled their revenue, they've doubled their profit and maintained an efficient business. However, sometimes our revenue may have doubled but the profit number has decreased and therefore the profit margin. This is where we start talking about all the smart decisions we can make in business to reduce this 'financial bloat' and make our business more efficient for us.

Calculating your Gross Profit Margin

Let's get into some examples so you can start to understand the different profit margins on a more practical level. Let's say you have a product-based e-commerce business, and maybe you're buying something for $3 and you're selling it for $15. The $3 cost sits as a direct cost of generating that revenue. Once you take away your direct costs from your revenue, you are then left with a number. So for ease, let's say in this month I've made $10,000 of revenue and I have spent $5,000 on direct costs to generate that revenue. Therefore I am left with $5,000 of gross profit. This is the gross profit number. Now, to get the percentage you simply divide the profit number by your revenue number and multiply it by 100. In this example, my gross profit percentage is 50%. What this means is that for every dollar, you're taking home 50 cents of gross profit.

At the basic level, your service, your product, or whatever it is that you're selling should be making a good profit margin. Everybody asks me, "What is a good margin, Lucy?" And my answer will always be, it depends. But I appreciate that's annoying, so what I will say is that your gross profit margin should at least be 50% if you're a product-based business, or if you're a service-based business, quite honestly you should be at 80% plus.

I go into a lot more detail on this in my Magic by Numbers program, where we really deep dive into the P&L with live examples. I'll leave the link down below for you if you're interested in learning this for yourself.

Calculating your Operating Profit Margin

So we have our gross profit number, now we need to add to this by taking away all of our operating expenses which will give us the operating profit margin. Operating expenses can include things like rent, wages and salaries, subscriptions, electricity, and accounting software.

Let's stick to our example where we generated $5,000 of gross profit and say that it's also costing us another $3,000 just to operate your business each month. Your operating profit would be $2,000 per month, and therefore your operating profit margin would be 20%. That's because $2,000 divided by $10,000 of revenue, multiplied by 100 equals 20%.

The Net Profit Margin

Our final profit margin to discuss is our net profit, which is essentially what you're left with after you pay tax. The current small company tax rate in Australia is 25%, so let's say for argument's sake on that $2000 I'm going to pay $500 in tax. So my net profit is $1500, meaning my business has actually generated $1,500 from $10,000 in revenue, which is a 15% net profit margin. You can see why it's handy to be able to reduce your tax rates where legally possible, as this will give you more dollars in your pocket and allow your net margin to increase.

Activity

If you have Xero, I recommend going to the top banner that says 'accounting'. Then, click the tab that says 'Profit and Loss'. Here you can find your profit and loss for any month or financial year. Unfortunately, Xero doesn't give you the profit margin percentage number, but it will show you the gross profit amount and your operating profit and you can calculate it from there.

The net profit is a little more difficult as Xero doesn't assume your tax number for you. The key here is to look at the gross and operating profits of your business so you can familiarize yourself with your numbers.

Final Thoughts

  • There are three types of profit margins: gross profit, operating profit, and net profit.
  • As a minimum, your business should have a 50% gross profit margin.
  • Determine how you can increase your profit margins by generating more cash and eliminating expenses: Can you get a new supplier that provides the same quality for a lower price? Can you increase your minimum order quantity to get a better per unit price? Can you increase your prices?

Hopefully, I've educated you as to what a profit margin is and why it's so important, and provided some ideas as to how you can tweak your operating and gross profits to give you more dollars back into the bank account.  

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