How Much Profit Should a Business Make?
Written by Bindi Gethen
Profitability isn’t a simple equation. It’s a comprehensive measure of the health and success of your business. It’s a multifaceted concept that extends beyond just the bottom line. You’ll need to factor in your business model, industry norms, and overall operational efficiency, among others.
So how much profit should a business make? We recommend aiming for a minimum 10% profit margin, but keep in mind that there’s no lucky number, golden rule, or one-size-fits-all answer. You want to minimise the risk of going bankrupt as much as possible.
Understanding Profit Margins: How Much Should Your Business Make?
Your profit margins are a quick health check for your enterprise. In other words, this metric tells you if you’re winning or drowning in the economic tide. When your profit margins are solid, you’re in the promised land, but if they are lean, you’re probably on the back foot, gasping for financial oxygen.
Let’s break it down. Profit margins are expressed as a percentage and indicate how much of every dollar of sales a company keeps in earnings. If you have a profit margin of 20%, for instance, it means you keep 20 cents from every dollar in sales, after accounting for all costs and taxes.
So what exactly is a good margin? Well, that varies widely depending on the industry, but generally, anything above 10% is often considered good.
Profit margins are more than just numbers on a page. They hold weight in the real world. A study conducted by NYU Stern in 2018, for instance, indicated that profit margins directly influence a company’s longevity. In their review of 7,000 firms across a multitude of sectors, they found that those with higher profit margins significantly outlived their counterparts with lower margins.
Now, let’s delve into a real-life example. Consider the case of Costco, a multinational corporation that operates a chain of membership-only big-box retail stores. Despite the company’s razor-thin profit margins, often around 2%, it has consistently managed to thrive in a highly competitive market. Costco’s strategy revolves around volume sales and membership fees rather than high margins on individual products.
But here’s the catch. What works for Costco may not work for your business. Again, profit margins are not a one-size-fits-all indicator. They should be customised to your specific industry and business model. Costco’s low-margin, high-volume model is a departure from the norm. For most businesses, thin profit margins can mean teetering on the edge of survival.
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Factors Influencing Profitability
1. Revenue Generation
The lifeblood of any enterprise is revenue. It’s the amount of money you make from selling your product or service before any costs are subtracted.
The thing is, revenue generation isn’t just about bringing money in; it’s about the consistency and quality of that revenue. For instance, recurring revenue – think of subscription models like Netflix or Spotify – provides a steady stream of income and can be a predictor of future profitability. Similarly, high-quality revenue, derived from selling high-margin products or services, is more beneficial than low-quality revenue from low-margin sales.
The ability to generate revenue is also influenced by factors such as pricing strategy, product quality, market demand, and effective marketing. The key is to balance these elements to maximize revenue while ensuring customer satisfaction and loyalty.
Deloitte, in a report on revenue generation, found a strong correlation between effective revenue management and profitability. Their research showed that companies with robust revenue management strategies reported significantly higher profit margins compared to those without.
In another research conducted by Harvard Business Review, it was discovered that the companies that were able to successfully balance cost-cutting and revenue growth investments were better positioned to do well after an economic recession.
2. Cost Management
Cost management, the second pillar of profitability, involves planning and controlling your business’s budget. It’s about the delicate art of cutting costs without bleeding out the value of your product or service.
Direct costs (e.g., raw materials, labour) and indirect costs (e.g., rent, utilities, taxes) all need to be considered. Keeping these costs in check and optimizing operations for efficiency can significantly improve your profit margins.
The iconic brand, Nike, is a testament to strategic cost management. They’ve achieved impressive profitability by investing in areas like research and development, while cutting costs through efficient supply chain management and strategic outsourcing.
Pro tip
Cost-cutting isn't always the answer. Smart cost management is about strategic spending. It means knowing when to invest in quality resources that will pay off in the long run and when to tighten the purse strings.
3. Competitive Landscape
Your competitors can have a significant impact on your profitability. If your business operates in a highly competitive market, you may have to work harder to attract and retain customers, which could affect your profit margins.
On the flip side, if your business offers a unique product or service with little competition, you might enjoy greater profitability. The key is to understand your competitive landscape and carve out a niche for your business.
A case in point is a specialty coffee shop in a city oversaturated with coffee chains. Despite the competition, the owner managed to carve out a niche for his business by focusing on artisan coffee and offering unique flavors sourced from around the world.
He also invested in excellent customer service and created a cozy ambiance that made his coffee shop a place people wanted to return to. As a result, despite the fierce competition, he managed to build a profitable business that stood out from the crowd.
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Boost Your Profitability With Our Virtual Bookkeeping Services
A well-managed business is a profitable business. Increasing your profitability starts with understanding your financial health – and this begins with proper bookkeeping. At The Bookkeeping Studio, we offer virtual bookkeeping services to businesses across Australia, helping them navigate their bottom line and turn it into strategic growth opportunities.
By outsourcing your financial management to us, you can focus on running your business, while we focus on enhancing your profitability. Get in touch with us to learn how we can help your business reach its financial goals.
Hey, my name’s Bindi Gethen! I’m the founder of The Bookkeeping Studio in Australia. With over 15 years of experience in the industry, I have a deep understanding of the challenges that small and medium-sized business owners face when it comes to managing their finances.
I am passionate about empowering my clients with the financial information they need to succeed. My team and I pride ourselves on our commitment to exceptional value, accuracy, and confidentiality. Our virtual bookkeeping services include payroll, budgets, and management reporting, among others.
Not to toot our own horn, but we can assure you that you won’t find a bookkeeping partner like us anywhere else in the Southern Highlands.
