Most small businesses make a surprisingly small amount of profit and have lower profit margins then you would expect.
I covered this in a previous post titled: How Much Profit Does the Average Small Business Owner Make a Year?
In the post, I concluded that the average profit margin of a typical small business in North America is approximately 7%.
Surprisingly, the average public believes that the typical small business owners make a 36% profit margin a year.
The 7% number means that, at the end of the month, and year, the average business puts 7% of revenues into their pocket as profit.
There are very few businesses in North America that make anywhere near a 15% profit margin. In fact, anything about a 13% profit margin will propel your business into the top 10% of businesses in the market.
Of course, profit margins vary from industry to industry, and between economic cycles, so it’s hard to generalize on all industries in aggregate, but, if you can improve your margins, then you will increase the total profits.
Profit Margins Explained:
As an example, if you can increase your profit margin from 7%, to a more reasonable number like 15%, then you’ve added an 8% additional margin as profit.
A quick calculation: if your business’s revenue is $2 million a year, and your profit margin is 7%, then you will earn a total of $140,000 as profit in the year ($2,000,000 X 7% = $140,000).
If you can increase your profit margin from 7% to 15%, for example, then in the above example, the profit will increase from $140,000 a year, to $300,000 per year, or an additional $160,000 into the small business owner’s hands.
It, therefore, goes without saying that every small business owner should be looking for ways to increase profit margins in the business.
Given the importance of profit margin to a small business, i.e. the higher the profit margin, the higher the profit that goes into your pocket, I will review a few ways that you can increase profit margin for your business:
19 Easy Ways to Increase Profit Margins for Your Small Business
- Increase Your Prices: This is a fairly obvious one, but, of course, you need to review your pricing strategies, and then, be careful that you understand the price elasticity of demand for your product. If you increase product prices too much, and sales decline at too high a percentage, then you might increase profit margin, but, in the end, lower overall profits.
- Stop Product Discounts: If your company is discounting product too frequently, lowering the discount level, or stopping discounts all together, will help to improve profit margin.
- Look for Product Seepage or Product Theft: this one is fairly obvious. It’s possible you have product going in through the front door and out the back door (in an employee’s pocket) without being accounted for. Watch for employee theft, and you will, of course, increase profit margin.
- Negotiate Vendor Discounts: the better the discounts, the more dollars into your pocket, the more you improve profit margin for your business.
- Negotiate Payment Terms with Your Vendors: ask your vendors if they will provide payment terms, for example, 2 10 net 30. This means that if you pay your invoice within 10 days, you will receive a 2% discount. The 2% goes to the bottom line, and also helps to increase profit margin.
- Negotiate Better Freight Agreements with Your Suppliers: If you can reduce your freight charges, you will reduce the overall cost to have the goods delivered to your door, and in turn, improve profit margin.
- Combine Orders with Your Suppliers: Rather then order multiple products on separate orders, if you can consolidate more product per shipment, then you will reduce shipping fees, and in turn, improve profit margin.
- Fire Some Customers: Not all customers are great for business. If you have a customer who is hurting your business, or, requesting product prices that you believe to be unreasonable, then maybe it’s time you fire the customer.
- Avoid Paying Your Employees Overtime: if and where possible, if you can avoid the larger expense of overtime fees, then you will help to improve your bottom line.
- Cut Down on Contract Workers: Similar to point 9 above, if you can cut back on contract workers, who typically make more than an employee on an hourly basis, then these cost savings will go directly to your bottom line as well.
- Elevate Your Brand and Position in the Market – a Gucci purse sells for way more than a no-name brand. A Pal Zileri suit sells for way more than a no-name suit. Building your small business’s brand, especially vis-a-vis your competitors, will help with the sale price, and in turn, increase profit margin.
- Reduce Waste – reducing waste includes things like paper, and ancillary products that your small business consumes, and maybe even uses in packaging, will help reduce overall shipping costs, and profit margin.
- Reduce Product Wastage and Breakage: I can’t even begin to imagine how many dollars we saw slip out the door in breakage. These are products that fall and break, snap, or get damages somehow, that you can’t go back to your supplier for return because the damage is your company’s fault.
- Add New Products to Your Product Mix – perhaps the products you have in your product portfolio could be complemented by adding some additional products, and hopefully with even better margins. For example, if your company sells couches, you could add coffee tables to your product portfolio, and increase the revenue per total sale.
- Alter Your Company’s Focus: this is in-line with number 14 above. If you can add additional products to your portfolio, or, for that matter, maybe even change your business’s focus slightly, then you can broaden your business’s appeal, and in turn, potentially increase your customer base and average revenue per order.
- Increase Your Company Size: With company size and scale, comes economies of scale. In other words, if you increased sales or revenue from $2 million to $3 million, you likely won’t need an additional photocopier, phone system, website, and so on, for your business. All of these saved expenses go directly toward the bottom line.
- Add Recurring Revenues to Your Business: If you can add additional products and services, as per point 14 above, especially recurring revenues, to each order, then your revenues will increase, and with that, additional profits.
- Find a Business Grant – there are many resources, and govt facilities, that will provide a business grant, often for free, to help build businesses in a specific sector. You can see if your business qualifies.
- Improve Management Efficiency – I’ve seen many businesses that operate too management top-heavy, i.e. too many managers and too few staff. If you can cut back on managers, then that will contribute directly toward your bottom line.
To speak to some of the above points, here’s a blog post I wrote recently that discusses small business profitability: 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.
How Does Increasing Profit Margin Help Profitability
With the 17 examples I provided above, if you can find a few ways to improve your small business’s revenues, with ideally long-term strategies, and ultimately, margins, then that will help improve profitability.
Let me provide a brief example:
Let’s look at business scenario number 1 with a simplified income statement:
Income Statement Example 1, Business ABC
- Revenues = $1,000,000
- Cost of Goods Sold (COGS) = $400,000
- Gross Profit = $600,000
- Operating Expenses (rent, salaries and so on) = $500,000
- Net Profit = $100,000
EBITDA operating profit margin to revenues = 10% ($100,000 / $1,000,000)
Now let’s review Business XYZ with profit margins of 15%
Income Statement Example 2, Business XYZ
- Revenues = $1,000,000
- Cost of Goods Sold (COGS) = $350,000
- Gross Profit = $650,000 (Gross Profit Margin = GP / Revenues)
- Operating Expenses (rent, salaries and so on) = $500,000
- Net Profit = $150,000
- EBITDA operating profit margin to revenues = 15% ($150,000 / $1,000,000)
Notice that, in the above example, the business improved its Gross Profit by $50,000. This improved gross profit improvement directly impacts the bottom line, or net profit, of the small business.
Here’s an excellent video that explains profit:
What is the Difference Between Margin Versus Markup
There’s one more area of confusion that I wanted to clarify. I speak with small business owners all the time, and they seem to be confused by the terminology of margin versus markup:
What is Margin? Margin is the amount of profit divided by the amount of revenue (for a company) noted as profit margin, or, the cost of a good, as a percentage, divided by the sale price of that good.
What is Markup? Markup is the total added to the price of a good. Let’s say the good costs $1,000, and the final sale price is $1,600, then the markup is $600, and as a percentage, 60%.
Although it’s importance is often neglected, the profit margin, and as a result, the amount of profit that the small business owner earns can vary with some slight product, supplier, pricing, or strategy business tweaks. Make some of those changes, and watch your profitability soar.
Good luck with your 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.
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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.