Profit Margins Matter: A Key to Business Health
Over the years, I’ve spoken with many small business owners about profit margins, and it’s often surprising how many don’t know what their profit margin is – or if they do, they’re shocked to learn how low it is. Some even struggle to understand why it’s important to track this key figure in the first place.
If you’re constantly in the weeds of your business, managing cash flow, investing in product development, staff, or advertising, it’s easy to lose sight of your margins. But here’s the truth: if your cash flow is struggling, the first place you should look is the “fat” in your profit margin.
Why Profit Margins Matter
When you have a healthy margin, it’s not just about keeping the business afloat; it’s about positioning yourself for long-term sustainability and growth. A good rule of thumb is to aim for a 70% gross profit (GP) margin. This means for every dollar of revenue you earn, 70 cents covers your costs, leaving you with room to reinvest in your business, pay yourself, and cover the essential overheads.
Why 70%? Running a business is expensive, no matter what product or service you offer. There are staff salaries, operating costs, marketing, inventory, and most importantly, the need to pay yourself as the owner. A 70% GP margin gives you enough “wiggle room” to cover those expenses and still make a profit. From there, aim for a net profit (NP) of 20% or more. This is a healthy margin that will help you weather tough times and prepare you for an eventual exit strategy, should you decide to sell your business.
Where to Start: Analyse Every Expense
If your margins are looking too thin, it’s time to dive into the details. Examine every area of your business where expenses are eating into your margins:
Shipping Costs: Shipping can quickly become a significant expense, especially if you're offering free shipping. Look at ways to streamline shipping processes, negotiate better rates with couriers, or adjust your pricing strategy to ensure that shipping doesn’t drain your profits.
Packaging: Are you overspending on packaging? While presentation is important, it shouldn’t eat into your margins. Consider more affordable, but still high-quality, packaging options that keep costs low without compromising the customer experience.
Stock: Unsold stock can tie up cash flow and eat into your margins. Regularly assess your inventory to ensure you're not overstocking products that aren't moving.
Supplier Payment Terms: Review the payment terms you have with your suppliers or wholesalers. Longer payment terms can improve your cash flow, but if you’re paying too soon or with less favourable terms, it can drain your resources faster than needed. Negotiating better terms with suppliers, such as extended payment windows, can help ease cash flow pressure.
Staff and Freelancers: Staff and freelancer costs can significantly impact your margins, especially as your business grows. Regularly assess whether you have the right balance of full-time staff versus freelancers or contractors. While freelancers can offer flexibility, make sure that their costs are sustainable and not eroding your margin. Likewise, ensure that your in-house team is aligned with business goals and contributing to profitability, rather than just being a fixed cost.
Warehousing and Subscriptions: Review your warehousing costs and any subscriptions to software or services that might no longer be necessary. Every little cost adds up, and it’s crucial to evaluate whether each expense is still providing value to your business.
A Lesson From My Own Experience
I am not an accountant, but as a business owner, I’ve seen firsthand how important profit margins are in growing and sustaining a business. Running a fast-growing business comes with its fair share of challenges, and it’s easy to get caught up in the day-to-day operations. But understanding your margins has been one of the most valuable lessons I’ve learned. This insight has kept my business profitable and allowed me to make smarter, more informed decisions along the way.
Profit Margins and Financing: A Boost When You Need It
Sometimes, in order to take your business to the next level, you may require a loan to give your growth an extra boost. Whether it’s for scaling operations, expanding your product line, or increasing marketing efforts, external financing can be a powerful tool. However, what many business owners don’t realise is that having a healthy profit margin is critical when it comes to securing and repaying that loan.
With a strong profit margin, not only will you have access to more funds to reinvest into your business, but you’ll also be in a better position to pay back the loan faster. Lenders are more likely to offer favourable terms if they see you have the financial health to manage debt and repayment. The extra "fat" in your margins provides the cushion needed to take on a loan without putting your business at risk.
Getting Into the Numbers
One of the best things you can do for your business is to get into your numbers every day. If finance isn’t your strong suit, delegate the responsibility to someone who is skilled at it – a bookkeeper, accountant or operations manager. Their expertise can help you understand the financial pulse of your business and keep you informed about the state of your margins.
Ignoring your numbers won’t make them go away. In fact, the longer you wait to understand and manage your profit margins, the harder it will be to turn things around. Make your numbers a priority – because if you don’t, you’re setting yourself up for financial uncertainty.
The Bottom Line: Margins are Your Lifeline
Your profit margin is more than just a number – it’s a critical indicator of your business health. Having a healthy margin is what allows you to grow, reinvest, pay yourself, and ultimately build a sustainable business. So, take the time to dive into your financials, trim unnecessary expenses, and adjust where needed. The result will be a leaner, more profitable business ready to take on whatever comes next.
