Much of the stuff I write about on this blog are things I’ve learned, and my entrepreneurial experiences running my business over the last 30 plus years.
And when you’re running a small business, there’s a lot to learn, and although I went to business school, many of the things I learned in school didn’t prepare me for how to run a small business.
I graduated with multiple entry and mid-level accounting courses. I understood most accounting terms, but I understood them as someone who studies a textbook.
From an accounting perspective especially, I rarely made the connection between the ratios and formulas you need to understand and study and the practical application in my small business.
In school, they prepare you as if you’re reading the income statement for a large business, not a small fledgling business like I was running. Same with the hundreds of ratios you need to understand in order to pass your courses, so when I graduated, I DID understand the terms gross margin, net margin, and profit margin.
I did NOT understand their importance and application to my business though, in particular, gross margin and profit margin, and as a result, I didn’t track these ratios.
When you’re running a small business, you’re looking to maximize profitability, i.e. how many dollars did you put into your pocket.
It was only in my later years did I really understand, and more importantly, track these financial ratios, expressed as a percentage.
And that’s why I write this blog.
To educate other small business owners on the nuances of running a business. To help them grow revenues, maximize profitability, and ultimately, create wealth.
And one of the most important ratios that a small business owner needs to track is the profit margin.
Why?
At the end of the week, month, and year, the profit margin is the amount of dollars that will find its way into your pocket.
The difference between 3%, and a 17% net profit margin, on revenues of a $1 million company, is the difference between $30,000, and $170,000, or, an additional $140,000 in your pocket.
Net Profit Margin Formula:
The formula for Net Profit Margin: Net income / Revenue X 100
Using the above example, a company that made $170,000 net profit on revenues of $1 million, will look as follows:
$170,000 / $1,000,000 X 100 = 17, or 17%.
The simplified income statement looks as follows:
Income Statement
- Revenue = $1,000,000
- COGS (Cost of Goods Sold) = $500,000
- Gross Profit = $500,000
- Expenses = $330,000
- Net Profit = $170,000
Now that we’ve got that out of the way, let’s review what the average profit margin is of the average business in North America. In other words, what percentage of dollars does the average small business put in their pocket every year?
Reason-Rupe did a study in 2013. They asked 1,003 people, the general public, what they believed the average profit margin was for a small business. The response was 36%.
In actual fact, the average small business doesn’t make anywhere near 36% net profit margin. It’s much less than that.
The Average Profit Margin for a Small Business in North America
The average profit margin is going to vary, of course, from business to business, and from industry to industry.
In a study done by the Government of Canada, titled: SME Operating Performance, and corroborated by the US Govt Small Business Administration survey, they looked at profits by sector, and the numbers varied big time. For example,
- Agriculture and Forestry = 8.4%
- Mining = -16.9%
- Construction = 4.6%
- Manufacturing = 2%
- Wholesale and Retail Trade = 2%
- Professional and Technical Services = 6.3%
Here’s the chart below:
Frankly, the results are somewhat abysmal.
In the blog post I wrote titled: How Much Profit Does the Average Small Business Owner Make a Year? I went through the calculations and determined that the average small business owner makes approximately a 7% average profit margin per year, again, not a very good number.
So, to answer the question: What is the Average Profit Margin for a Small Business in North America? The average small business in North America makes a profit margin of approximately 7%.
So, the next and logical question is:
How Do You Increase Profit Margins for Your Small Business:
I wrote a blog post titled: 19 Easy Ways to Increase Profit Margins for Your Small Business
In the blog post, I reviewed a number of creative ways that any business can improve their profit margins, and in turn, improve their profitability. Remember, if your business’s revenue (net income) is $1 million, and your EBITDA margin is 7%, as per the example I provided above, for every additional percentage you raise your EBITDA margin, your business’s profitability increases by $10,000.
In the blog post, I listed a number of ways to improve profit margins, for example:
- You can raise the prices of your products. Raising prices will depend on the price elasticity of demand for your product, but, it is an option to consider.
- You can stop offering product discounts
- Negotiate better terms with your suppliers. This is potentially an easy one. I renegotiated terms with one of my suppliers a couple of years ago, and managed to save my company over $180,000 in savings. You can bet that definitely increased my EBITDA margin percentage.
Before you go, here’s another blog post on profitability I think you might enjoy: How Much Profit Does the Average Small Business Owner Make a Year?
Good luck with your business and wealth-creating journey..
Glossary Terms: Margin Versus Markup
A quick explanation:
What is Margin? Margin is the percentage of dollars that end up in your pocket, income, as a percentage of overall revenue.
What is Markup? Markup is the amount added to the cost of a product. So, for example, if a product cost $100, and the sale price is $150, then the markup is $50, and when noted as a percentage, the markup is 100 X Profit / Cost, or, in the above example, 100 X $50 / $100, or 50%.
Margin Markup Table: In order to assess the amount of profit margin your small business is making, it’s important that you track the profit margins on a per-product basis, and for that, you can put your products into a margin markup table, which would look as follows:
Good luck with your small business and wealth-creating journey.
If you enjoyed this post, you might also enjoy this one: Profit Isn’t a Disease. It’s the By-Product of a Well-Run Company. If You’re Not Yet Profitable, Fix It or Get a Job.
And this one: How Do You Know When It’s Time to Sell Your Business? It’s Not All About the Money.
You should also consider subscribing to my blog. I publish one article a week on small business and wealth creation. You can subscribe here.
Also, I published a book during the summer of 2018, “The Kickass Entrepreneur’s Guide to Investing, Three Simple Steps to Create Massive Wealth with Your Business’s Profits.” It was number 1 on Amazon in both the business and non-fiction sections. You can get a free copy here.
