What is a reasonable profit margin for a small business? (& how to calculate yours)

Understanding profit margins is a fundamental step in running a healthy small business. The relationship between what you make and what you spend determines whether you have a successful, sustainable business, or you’re in trouble. 

And in a tighter economic climate, where interest rates remain (relatively) high and fewer investors are handing over funds, smart businesses are focused on their margins. 

In this article, we look at the different kinds of profit margins businesses measure. We also examine some benchmark figures for what a reasonable profit margin might look like in your industry. 

And we finish with five ways to improve your profit margins relatively quickly. 

The key types of profit margin

While it’s common to hear small business owners talk about their profit margins, there are actually several different versions of this metric. 

Here are the most commonly-used profit margin definitions, and how to calculate them. 

Gross profit margin

Gross profit margin is your leftover income after deducting the cost of goods sold (COGS). It’s essentially the amount of money you make from selling a product, once you remove the specific costs associated with sourcing, producing, and selling that product. 

Formula for gross profit margin

• ‍Gross profit = revenue - cost of goods sold
• ‍Gross profit margin = (gross profit / revenue) x 100

The gross profit formula only includes COGS, and therefore doesn’t factor in other company costs such as operating expenses and certain staff salaries. It’s a good way of assessing the potential profitability of specific products, without considering the overall efficiency of your business. 

Operating profit margin

Your operating profit margin is the leftover revenue once you deduct COGS and operating expenses. This therefore includes all the broader costs that come with running your business, not limited to buying and selling goods. 

Formula for operating profit margin

• ‍Operating profit = revenue – cost of goods sold – operating expenses
• ‍Operating profit margin = (operating profit / revenue) x 100

Because it includes these wider expenses, operating profit margin is a more accurate reflection of your company’s profitability. It’s also still relatively easy to calculate, with perhaps less gray area than net profit margin, which we’ll see next. 

Net profit margin

Net profit margin is the income you have left over once you deduct COGS, operating expenses, interest, and taxes—essentially all your company’s outgoings. This is therefore the truest profit measure, even if it can be complicated to measure. 

Net profit margin formula

• ‍Net profit = revenue – cost of goods sold – operating expenses – interest – taxes
• ‍Net profit margin = (net profit ÷ revenue) x 100

In some cases, operating profit margins may actually be a more pragmatic lever for long-term success. Interest and tax rates can change and are often out of your control. You may be better to focus on reducing COGS and operating expenses, as these are largely determined by your own processes. 

On the other hand, taxes and interest really do reduce your profits. And you’re unlikely to avoid them altogether, so it makes sense to consider them.

What is a reasonable profit margin for an SMB? 

The answer to this question depends mostly on your industry, as well as your local market and the kinds of clients you serve. Some young startups aren’t even expected to make a profit for years, and are measured more on growth potential than their current balance of revenue and costs. 

A common rule of thumb is that 20% is a good net profit margin. 10% is fine and likely sustainable, and going too much below this can be risky. 

But because this can vary wildly by industry, it’s best to try to benchmark your profit margins against similar businesses. 

Average profit margin by industry

Based on an ongoing study from NYU, we have some industry benchmarks to help you (somewhat) objectively measure your margins. These are specific to the United States and likely concern publicly traded companies, but provide a fair reflection of the broad differences between industries.

In other words, use them as an indication, but not gospel for your own small business. (Figures updated October 2024.)

• Advertising: Gross = 28.11% | Operating = 12.26% | Net = 0.89%
• Beverage (alcohol): Gross = 45.25% | Operating = 21.20% | Net = 8.59%
• Beverage (soft): Gross = 54.52% | Operating =19.83% | Net = 13.73%
• Business & consumer services: Gross = 33.50% | Operating = 12.48% | Net = 5.45%
• Computer services: Gross = 25.52% | Operating = 7.80% | Net = 4.40%
• Engineering/construction: Gross = 13.85% | Operating = 5.02% | Net = 1.67%
• Entertainment: Gross = 38.09% | Operating = 9.12% | Net = -0.23%
• Farming/Agriculture: Gross = 16.49% | Operating = 10.40% | Net = 7.12%
• Food wholesalers: Gross = 14.86% | Operating = 2.35% | Net = 1.21%
• Farming/Agriculture: Gross = 16.49% | Operating = 10.40% | Net = 7.12%
• Healthcare Products : Gross = 55.64% | Operating = 15.58% | Net = 8.19%
• Information services: Gross = 32.72% | Operating = 13.03% | Net = 3.49%
• Insurance (general): Gross = 33.93% | Operating = 16.35% | Net = 8.88%
• Investments & asset management: Gross = 66.89% | Operating = 19.30% | Net = 19.82%
• Oil/gas (production & exploration): Gross = 58.75% | Operating = 38.24% | Net = 28.26%
• Packaging & containers: Gross = 21.71% | Operating = 10.16% | Net = 2.85%
• Real estate (general): Gross = 46.70% | Operating = 18.30% | Net = 16.91%
• Restaurant/dining: Gross = 32.43% | Operating = 17.26% | Net = 10.66%
• Retail (automotive): Gross = 21.88% | Operating = 6.44% | Net = 4.32%
• Retail (distributors): Gross = 32.34% | Operating = 12.34% | Net = 7.55%
• Retail (general): Gross = 30.86% | Operating = 5.99% | Net = 3.09%
• Software (entertainment): Gross = 63.43% | Operating = 35.36% | Net = 20.35%
• Software (system & applications): Gross = 71.52% | Operating = 34.05% | Net = 19.14%
• Transportation: Gross = 25.12% | Operating = 9.31% | Net = 5.96%

The overall average gross profit margin was 36.56%, while the average operating margin was 12.97% and the average net margin was 8.54%. This shows what a difference operating expenses, tax, and interest can make. 

Banks and money centers had the highest net profit margins right around 30%. Oil/gas exploration, tobacco, and railroads were also highly profitable, according to this study. 

Interestingly, the Software (Internet) sector has gross margins of nearly 60%, but net margins of -14.32%. This is likely due to the aggressive growth rates recently in the tech industry, where companies took on large amounts of debt and equity investments. The products themselves are low-cost to produce, with very few overheads, but the market is so competitive that companies choose to spend heavily to get ahead. 

Overall, these provide an interesting insight into how gross margins can be very different from net. And they give a broad gauge of what reasonable profit margins look like in those 24 industries. 

So if you’re below par or not currently happy with your own profit ratio, what can you do about it? 

5 ways to improve your SMB profit margins

There are two broad ways to improve profit margins: bring in more revenue at the same cost, or bring in the same revenue at reduced costs. Here are five suggestions to do just that.

1. Find & reduce operational inefficiencies

While some costs are unavoidable, most businesses can find areas to reduce them if they look hard enough. These aren’t necessarily the really hard decisions—we’ll get to those shortly. This is about finding the smart ways to operate more smoothly and eliminate added extras in your processes. 

Typical SMB inefficiencies include: 

• Overstocking products or materials that don’t sell quickly (or at all)
• Manually handling customer orders, shipping, or communications that could easily be automated
• Paying penalties, interest, or late fees on outstanding invoices or obligations
• Overstaffing
• Slow supply chains or delays
• Ineffective customer experiences—like long lines or slow check outs—which cause clients to take their business elsewhere
• Security issues (including hacks and online scams)

Any efficiency gains that lead to either more revenue coming in or fewer operating costs are a major win. 

2. Manage inventory carefully

Inventory management is about finding the Goldilocks zone where your level of inventory is just right. This involves:

• Not overstocking and tying up resources
• Not running out of stock and failing to serve real demand

Stock is obviously a cost until it’s sold. If it remains unsold forever, you never recoup that cost, and your profit margin shrinks. 

There are also the storage costs of holding inventory, and potential opportunity costs of tying up your funds in unsold inventory. 

Long story short, you need just the right amount of inventory to maximize sales while minimizing spend. It’s a tricky balance, and the only real solution is to be intentional and focused in this practice. 

If capital is an issue, consider inventory financing to get the stock you need now without tying up necessary funds. This short-term credit lets you take advantage of a current boost in demand, even if you don’t have the cash on hand to purchase the goods you need. 

3. Focus on more profitable products

This is an obvious recommendation, but not every small business knows immediately which products are their most profitable. This is the value of calculating COGS properly, to accurately include all of the costs going into each specific item. 

Depending on your industry and business model, you may have whole categories of product or service more profitable than the others. Or you may have individual products within a range that outperform the rest. 

Your analysis may also identify highly profitable products that aren’t selling at the rate you’d like. This could be a lack of demand—in which case there’s no reason to focus on them. But it could also be a lack of awareness among buyers. 

Simply put: are your most profitable items front and center in your shop window or on your website? 

4. Cut costs

There’s a philosophical difference between reducing inefficiencies—”trimming the fat”—and cutting core costs. But at a certain point, if the profit margins aren’t there, you can’t afford to keep spending as you are. 

The most obvious examples of cost cutting are: 

• Downsizing staff numbers
• Reducing your number of branches or physical locations
• Removing certain staff perks and benefits
• Limiting trading hours

All of these are painful. And needless to say, you should start with “unnecessary” costs and luxuries first (your inefficiencies), before looking at physical spaces and people. 

It may be possible to do this without impacting the quality of your products and services. But quality is likely to take a hit. Just how much you can live with and still be proud of is a key question. 

5. Improve collections

Also known as Days Sales Outstanding (DSO), the time it takes you to get paid is an important consideration. If you’re looking at profit margins for the month of May, for example, but most customers don’t pay until July, your May margins may be lower than you’d like. 

This is normal and factored into more advanced accounting, but we want to keep it simple. If possible, the money you spend on goods sold today should bring new money in tomorrow, not next month, or next quarter. The shorter your payment cycles, the more working capital you have available and the more profitable your business appears. 

But on a more fundamental level, you need to ensure that every customer pays. On time and in full. Any resources you devote to chasing payments is another inefficiency, and one that directly hurts your revenue. 

So look for frictionless and easy ways to get clients to pay. And consider whether options like Buy Now Pay Later or receivables financing could help customers pay more easily, and keep the cash flowing into your accounts. 

Fix your cash flow for healthy margins

Not all advice to improve profit margins is easy to act on. If there was a simple trick to sell more products or lower your expenses, of course you would have done it by now. 

But one oft-overlooked part of running a small business is cash flow management. This is the process of ensuring that money flows in and out of your business efficiently, predictably, and that access to capital is never what holds you back. 

Short-term financing can be the key to cash flow. Having a direct line to safe, flexible, and sustainable funding makes a huge difference. 

Learn more about working capital financing for small businesses.