What is a good profit margin for your business?

A good profit margin for your business typically ranges from 5% to 20%. However, this can hinge on a range of factors such as your industry type, the size of your company and how long you’ve been in business. Regardless, a profit margin is an important metric that helps indicate the financial health of an organization. 

Here’s an in-depth look at the different types of profit margins, factors that influence a good profit margin and how you can help improve the profit margin for your business. 

What you’ll learn:

• Expressed as a percentage, profit margin measures how profitable a business is after subtracting the costs of running the company, such as operating expenses.

• The common types of profit margins include net profit margin, gross profit margin, operating profit margin and EBITDA margin.

• Profit margins can differ based on factors like business size and industry type, with certain industries generating higher profit margins than others.

• Businesses can improve their profit margins by reducing operating costs, increasing prices and improving customer retention.

A profit margin measures how much your business makes from its sales after covering other costs, such as operating expenses. It’s usually expressed as a percentage and illustrates how much of every dollar of revenue becomes profit.

Revenue is the total income a business earns from its operations before subtracting expenses. But profit margin is a better measure of how well the company is doing because it accounts for the additional costs associated with running the business.

There are several different types of profit margins that can be used to assess the profitability of a business. Here’s a breakdown of each:

Net profit margin is the most common type of profit margin. It accounts for all expenses, like operating costs, cost of goods sold (COGS), interest, taxes and other expenses—providing business owners with the most comprehensive margin metric. It’s best used to assess your company’s true bottom-line profitability.

The formula to calculate net profit margin is:

Net profit margin is the most common type of profit margin. It accounts for all expenses, like operating costs, cost of goods sold (COGS), interest, taxes and other expenses—providing business owners with the most comprehensive margin metric. It’s best used to assess your company’s true bottom-line profitability.

The formula to calculate net profit margin is:Net income is calculated by subtracting all expenses such as COGS, operating expenses, interest, taxes and other costs from total revenue. For example, if your business generates $100,000 in revenue and has $85,000 in expenses, your net profit is $15,000, resulting in a 15% net profit margin. This means that for every dollar of revenue, the company retains 15 cents as profit.

Net income = $100,000 - $85,000 = $15,000.

Net profit margin = ($15,000)/$100,000) x 100 = 15%

Gross profit margin measures how much revenue your company makes after subtracting COGS, which includes the costs of materials and labor used to produce the product. It’s also expressed as a percentage of the business’s total revenue.

Here’s the formula used to calculate gross profit margin:

So, say your company made $150,000 in net sales and the COGS totaled $70,000. The gross profit margin in this example would be 53.3%.

Gross profit margin =  ($150,000 - $70,000 / $150,000) x 100 = 53.3%

Gross profit margin differs from gross profit in that gross profit is the actual dollar amount a business makes after subtracting COGS from its revenue. Gross profit margin, on the other hand, reveals how efficiently the company is producing and selling products relative to its revenue. In the example shared above, the gross profit would be $80,000.

Gross profit = $150,000 - $70,000 = $80,000

Operating profit margin, also called operating margin, is another important metric business owners use. It measures how much profit the company makes after accounting for operating expenses like rent, salaries and administrative costs—but before interest and taxes. It’s generally used to show how efficiently a company is running its day-to-day business operations. 

Operating profit margin is calculated by dividing the operating income, which is revenue minus COGS and operating expenses, by total revenue. The formula looks like this:

For example, if the business generates $100,000 in revenue, with $50,000 for COGS and $20,000 in operating expenses, the operating income would be $30,000. Divide $30,000 by $100,000 and multiply that by 100 to get a 30% operating profit margin.

Operating income = $100,000 - $50,000 - $20,000 = $30,000.

Operating profit margin = ($30,000 / $100,000) x 100 = 30%

A higher operating profit margin generally indicates that the business is more profitable and running more efficiently.

EBITDA stands for earnings before interest, taxes, depreciation and amortization. It’s another financial metric used to measure profitability, but it focuses more on how efficiently the business runs its core operations. Since it excludes noncash expenses like depreciation and amortization, EBITDA makes it easier to compare financial performance across different companies. 

EBITDA margin can be calculated similarly to other profit margins. There are two formulas used. The first, which is based on net income, looks like this:

So, if a business has $100,000 in revenue and EBITDA of $10,000, the EBITDA margin would be 10%. A higher EBITDA margin indicates that the business is more profitable from its core operations.

EBITDA margin = ($10,000 / $100,000) x 100 = 10%

The second formula is based on operating income, which also reflects core operations but focuses more on operational efficiency. That formula looks like this:

EBITDA margin = (Operating income (EBIT) + Depreciation + Amortization) / Net revenue x 100

For example, if a business has $100,000 in revenue and EBITDA of $15,000, its EBITDA margin is 15%.

EBITDA margin = ($15,000 / $100,000) x 100 = 15%

The net income formula includes interest and taxes, so to calculate EBITDA, you need to add back in those costs. On the other hand, the operating profit method already excludes interest and taxes, making it a simpler and more direct way to calculate EBITDA. This often leads to a higher starting point.

Generally, a profit margin of 20% or higher is considered good. The profit margin shows how stable and profitable your business is and tells investors and creditors how effectively you’re managing your cash. 

When it comes to determining what a good profit margin is for your company, look at a few key factors:

• Industry: Some industries have much lower operating costs than others. For example, an auto repair shop needs space to work on cars and various equipment, while a software consultant doesn’t require an office and can work from home.

• Business size: The size of a company also impacts its profit margin. Larger companies can often automate processes and negotiate better deals, resulting in lower costs per unit and higher profit margins. On the other hand, small businesses in niche markets may charge a premium for their specialized products or services, enabling them to achieve higher profit margins than larger businesses. 

• Years in business: Newer businesses often have fewer employees and lower overhead costs, which can result in higher profit margins. But as the business grows, profit margins typically stabilize and may decrease as the company expands its product offerings, hires more employees and invests in larger facilities and processes.

Profit margins can vary significantly across industries. This is due to factors including cost structures, competition and pricing power.

Certain industries, like software and pharmaceuticals, generally have higher profit margins because they have lower variable costs and stronger pricing power. But industries like retail and advertising tend to have lower profit margins because they face more competition and higher operating costs.

If you’re a small-business owner just getting started, it’s essential to evaluate the profit margins of other companies in your industry to get a feel for the industry average. 

Additionally, the NYU Stern School of Business regularly publishes margin data for various industries, which can give you a better idea of the average margins for your type of business.

Regardless of your industry, there are steps you can take to help improve your business’s profit margin. 

• Reduce your operating costs. Review your operating costs to help identify where you might be able to cut some expenses—without compromising the quality of your products. You can consider renegotiating contracts with suppliers, putting a cap on employee spending or automating repetitive tasks.

• Strategically increase your prices. Part of your business’s pricing strategy should be to regularly analyze your current prices to ensure you’re staying competitive. Even a small price increase could significantly boost profit margins—especially if your products are in high demand.

• Enhance customer retention. Once you’ve built a customer base that generates recurring revenue, focus on maintaining and expanding those relationships. Create personalized marketing campaigns, develop relevant customer loyalty programs and ensure you’re always providing an excellent customer experience to help retain existing customers.

• Optimize your product or service offerings. Identify any products or services that aren’t generating strong profits for your business. You can run a break-even analysis to gain valuable insights into your business’s profitability, pricing and future planning. This will help you better understand which products offer the best profit margins.

Profit margin is a key financial metric that helps you understand your company’s overall financial health. Common types of profit margins, like net profit margin, gross profit margin, operating profit margin and EBITDA margin, offer valuable insights into your company’s performance. Just keep in mind that factors like industry type and business size can affect profit margins. So, when evaluating your company’s profit margin, be sure to compare it to standards in your specific industry for an apples-to-apples comparison.

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