Running a small business means facing an endless stream of daily numbers—sales and expense reports, inventory costs, and payroll figures… Oh my! How do you know where to focus with all these metrics competing for your attention? Which numbers can actually tell you if all your hard work is paying off?
Without a solid idea of where your business stands, you might be making critical business decisions in the dark. Perhaps expanding product lines that aren’t actually giving you meaningful returns. Or maybe turning down growth opportunities because you can’t clearly see the financial impact.
This is where your profit margin may become your most valuable compass. This straightforward metric reveals exactly how much your hard-earned revenue stays with your business as actual profit. Understanding and improving your profit margin generally provides insight into your operational efficiency and even helps guide decisions about pricing, expenses, and growth strategies.
In this article, we'll break down what profit margin means for small businesses like yours, how to calculate it, what makes a good profit margin for small business, and practical strategies to improve it over time.
What is a profit margin?
A company's profit margin tells you how much of your business's revenue turns into actual profit. It reveals how much profit your business is actually generating from sales. It helps you set realistic goals and measure your progress in concrete terms. Additionally, financial institutions like SmartBiz Bank℠ generally request to review your business's profit margin to assess its overall financial health when you apply for funding.
Operating profit margin
Operating profit margin sits between gross and net profit margins in terms of what it measures. Think of it as your “day-to-day operations” profitability metric. It shows what your business earns after covering variable costs like materials and labor, as well as regular operating expenses, but before paying interest or taxes. This metric answers the question: “How efficiently is my core business running?”
For example, suppose two restaurants have identical gross margins on their menu items, but one has streamlined kitchen operations and lower utility costs. In that case, that restaurant will show a higher operating profit margin. Knowing your operating profit margin can help you decide if you need to focus on operations or pricing first.
Gross profit margin
Gross profit margin zooms in on your products or services themselves. Think of it as your "product profitability” metric—what you earn from your offerings after covering just the direct costs (think materials, production labor, etc.) and before factoring in all those other business expenses. It answers the simple question: "After covering the direct costs of my product, how much am I keeping from each sale?"
For example, if you sell handcrafted furniture, your gross profit margin looks solely at the cost of wood, hardware, and the labor to build each piece against what customers pay. Why is this important? A healthy gross profit margin means you’ve priced your offerings correctly. It helps you know when you’ve found that sweet spot between cost and value.
Net profit margin
Net profit margin tells the complete story of the profitability of your business. It accounts for everything—not just product costs, but rent, utilities, payroll, marketing, taxes, and every other expense your business faces. It answers the crucial question: "After everything is paid, what percentage of each sales dollar actually becomes profit?" This bottom-line metric reveals whether your entire business model is working effectively.
When your net profit margin trends upward, it generally means you're making smart decisions across all aspects of your business. It's the number banks and investors care about most, and the one that ultimately determines whether your business is truly thriving rather than just surviving.
What your profit margin says about your business
Your profit margin is like your business financial report card. It cuts through all the day-to-day chaos to tell you the one essential truth: how effectively you’re turning sales into actual profit. When you know this number, you’re no longer just guessing about your financial health.
Your margin also reveals trends over time and helps with financial planning. Seeing a steady decline? Perhaps costs are creeping up or your pricing hasn't kept pace with expenses. On the flip side, if your margin is growing, your business decisions are generally moving you in the right direction.
Variables that affect a small business's profit margin
Several factors may influence your company's profit margin:
Labor costs. As a key factor in your cost of goods sold (COGS), labor costs strongly affect how much of your revenue you keep as profit. The less you're spending to produce what you sell, the less money from your sales goes toward covering your costs. The result is generally higher profit margins.
Inventory. When you have stock sitting unsold in your warehouse, the sale price of these items is potential future income that your company can't currently access. Put another way, the less stock you have on your shelves, the less money you've spent acquiring inventory that you haven't yet converted to profit. Additionally, inventory management software can be an expensive business cost that reduces your profits.
Taxes and regulations. If your company is a corporation, it will pay 21% of its revenue as taxes. If your company is instead a sole proprietorship or partnership, its income will pass through to its owners as personal income and be taxed accordingly. Since many non-corporations don't pay corporate taxes, they may sometimes have higher profit margins than corporations (even if corporations are often profitable in their own right).
Location. Your company's tax obligations may vary based on its location, as most but not all states charge additional business taxes. If your business is based somewhere with no state-level corporate taxes, your company may have a higher profit margin compared to its out-of-state competitors. Additionally, since renting or buying commercial real estate may be more expensive in major metropolitan business hubs, companies based in cities may have different profit margins than businesses in other locations.
Use of assets. Smart use of assets may increase your company's return on investment (ROI) and thus improve your profit margin. The more revenue dollars your asset use generates, the higher your profit margin typically becomes.
Equipment maintenance. Your equipment is among your key assets, and outdated or failing equipment prevents you from offering the most products or services possible. That said, upgrading your equipment often costs enough money that temporarily smaller profit margins could result. However, better equipment often leads to more productivity and thus higher profit margins in the long run.
Cost control systems. Even if the term "cost control systems" sounds unfamiliar to you, chances are your company has them. They include any budgeting processes, as any approach to identifying and lowering your operating costs is a cost control system. Properly using such systems can generally increase your profit margins.
How to calculate profit margin: Gross vs net
Understanding how to calculate profit margin is simpler than you might think. There are two primary calculations that give you different insights into your business’s financial health: Gross profit margin vs. net profit margin. Each tells its own important story.
- Gross profit margin: This measures the profitability of a single product, not your whole business. So if it costs you $40 to make a single product but you sell it for $50, your gross profit margin will be $10 divided by $50, which is 20%.
- Net profit margin: You'll most likely use this calculation to judge how profitable your business is overall. Take your company's total sales for a specific time period, subtract your total expenses, and then divide that number by your total revenue. So if your business made $500,000 last year and had expenses of $350,000, your net profit margin would be ($500,000-$350,000)/$500,000 = 0.30, or 30%.
The profit margin formula
Each type of profit margin has its own formula into which you can quickly plug numbers from your financial statements. Using a spreadsheet program like Microsoft Excel® can make it especially straightforward to calculate your profit margin.
The gross profit margin formula is:
Gross profit margin = (Net sales - COGS)/Net sales
The net profit margin formula is:
Net profit margin = (Revenue - COGS - Operating costs - Other expenses - Interest - Taxes)/Revenue
or, more simply:
Net profit margin = Net income/Revenue
Seeing these formulas written out may make it clearer that net margins account for far more real-life business expenses than gross margins do. As such, you may want to primarily use net margins for your profit margin calculations.
Average small business profit margin by industry
Profit margins vary significantly from one industry to the next. Here’s a snapshot of small business profit margin by industry using data available (2025) from NYU’s Stern School of Business:
- Computer services: 24.14% gross profit margin and 4.15% net profit margin
- Engineering/Construction: 14.45% gross profit margin and 2.95% net profit margin
- Electronics: 25.19% gross profit margin and 5.62% net profit margin
- Farming and agriculture: 14.70% gross profit margin and 4.90% net profit margin
- Food wholesale: 15.36% gross profit margin and 1.34% net profit margin
- Food retail: 26.09% gross profit margin and 1.97% net profit margin
- General retail: 32.22% gross profit margin and 4.60% net profit margin
- Insurance (general): 36.83% gross profit margin and 4.16% net profit margin
- Office and equipment services: 37.29% gross profit margin and 1.06% net profit margin
- Retail (automotive): 22.31% gross profit margin and 3.33% net profit margin
- Restaurants: 32.90% gross profit margin and 10.62% net profit margin
The above numbers may give you the best answer to the question, "What's a good profit margin for small businesses?" However, keep in mind that while these may help with targeting a good profit margin, there are other factors (location, size, etc.) that may play a role in determining the profit margin for your unique business.
Good profit margins
When it comes to ideal profit margins and what is a good profit margin for small business, there's no single number to target. Unless you consider your industry, expansion goals, and unique business situation, comparing your profit margins to other businesses' typically won't tell you much about your financial health.
Industry averages: With data like NYU's Margins by Sector, you can see how your company compares to the industry benchmark. Remember to take your geographic area into account too, as regional factors may influence what constitutes a "good" margin.
Business growth: A healthy profit margin will also depend on your expansion goals. When you're looking to make a large purchase, you might want your profit margins to be slightly higher so you can budget for the future.
Business age and size: As a general rule, newer businesses usually have higher profit margins because of lower overhead costs. As operations grow, profit margins might decrease as you add infrastructure and staff.
Tips for improving your profit margin
Now that you understand what profit margin is, let’s talk about practical ways to boost those numbers. Improving your margins doesn’t always require dramatic changes—sometimes, minor adjustments may make a significant difference.
Cut costs (without cutting corners): Generally speaking, the most obvious way to improve your profit margin is to reduce expenses. Since profit margins represent how much of your revenue you're keeping after costs, lowering expenses may be a quick boost to your bottom line. Look for inefficiencies in your operations, negotiate better terms with suppliers, or consider technology solutions that might streamline processes. Keep in mind, the idea is to eliminate waste, not value.
Don't just sell more – sell smarter: More sales doesn’t automatically mean better profits. What matters is selling the right products. Analyze which of your offerings generate the highest margins. Once you identify your high-margin rock stars, focus your marketing efforts behind them, or develop similar offerings. Consider discontinuing products that consistently drag down overall margins. While it may be hard to let go of anything generating revenue, pruning low-performers will generally free up resources for more profitable areas. Selling smarter means making informed choices about what you sell, not just how much.
Master your inventory: Inventory management directly impacts your profit margin. Too little inventory means missed sales opportunities, while excess stock ties up capital and may lead to markdowns or waste. Finding the right balance generally requires understanding your sales cycles and customer demand patterns.
Raise prices (strategically): Many small business owners resist raising prices for fear of losing customers. But thoughtful price increases may significantly improve your profit margins without driving away business. The key is adding value alongside price increases. Enhance customer service, add complementary services, or improve the product. When customers feel they’re getting more, they’re generally less likely to resist paying more.
Why profit margin matters for small businesses
You might be wondering if all this focus on profit margins is really worth your time. After all, you’ve got customers to serve and employees to manage—why obsess over one financial metric?
The truth is, your profit margin isn’t just another number in a spreadsheet. It’s a vital sign that tells you whether your business is financially healthy or heading for trouble.
Financial health
Think of your profit margin as your business's annual physical exam. Just like your doctor checks your blood pressure and cholesterol, your profit margin provides critical information about what's happening beneath the surface of your business. A strong, consistent margin indicates everything is working in harmony—your pricing makes sense, your costs are under control, and your business model is sound.
Business decisions
As a small business owner, you know that every business decision you make ultimately impacts your bottom line.
- “Am I ready to hire another employee?”
- “Should I expand a product line?”
- “Is it time to move to a larger location?”
Knowing your profit margin may help you make those decisions with confidence. Your profit margin acts as a reality check for your ambitions. It’s not to limit your dreams, but to ensure they’re built on solid financial ground.
Securing funding
When you’re ready to take your business to the next level, lenders and investors want to ensure their money will be in good hands. Your profit margin is often the first place they look. A healthy profit margin tells financial institutions that your business generates enough profit to handle loan repayments comfortably. Strong margins may even help you get better loan terms and potentially higher funding amounts.
How to improve your profit margin
Once you know where you stand, you may want to look into improving your profit margin year over year. Some areas to consider are operating expenses and sales. If you find certain products are too costly to maintain or find opportunities to boost incoming revenue, consider acting on those chances at growth. A healthy profit margin doesn't happen by accident—it's the result of intentional decisions and consistent monitoring that keep your business financially strong.
Understanding your business’s profit margin takes paying attention to your individual situation. With the right tools, you can use the number to discover areas for growth and expansion.
