A profitable startup is a successful startup. If you want to determine how much profit your startup is —and could be—making, you’ll need to calculate the gross profit margin for your business by taking your revenues and subtracting the direct costs of producing your products and services.
From there, you’ll divide this figure by your revenue. Then multiply the resulting number by 100 to determine your gross profit margin percentage. This sounds simple enough, and indeed it can be. But calculating your true profit margins requires you to take into account a range of accurate financial data and use the right formulas to get to your final profit margin.
Here’s everything you need to know about calculating your startup’s profit margins and why you should.
What Is a Profit Margin?
Your startup’s profit margin is a figure that indicates the profitability of your small business. There are a few different types of profit margins, including:
● Gross profit margin. This indicates the amount of money left over for your business after you’ve subtracted direct costs like labor and materials to produce your products and services. Gross profit margins tell you if your sales are sufficient enough to produce profits, and are excellent metrics for performing competitor comparisons.
● Pre-tax profit margin. This margin indicates the profitability of your business before tax deductions and helps you to determine the general direction your startup is heading in.
● Operating profit margin. This profit margin includes your admin and operational expenses and is calculated without tax or interest. Your operating profit margin will tell you how efficiently your startup’s resources are being allocated and used.
● Net profit margin. Your net margin, or your ‘bottom line’, is the revenue percentage that remains after all deductions, including operational expenses, interest, stock dividends, and tax. Positive results show that your startup is making more money than it’s spending, and vice versa.
Profit Margin Calculation Formulas
These are the formulas for calculating each type of profit margin mentioned above:
Gross Profit Margin Formula
(Total startup revenues – the cost of goods sold)/total revenues x 100 = GPM
Pre-Tax Profit Margin Formula
(Total earnings before tax/revenues) x 100 = P-TPM
Operating Profit Margin Formula
(Startup’s operating earnings/net sales revenues) x 100 = OPM
Net Profit Margin Formula
(Operating profits – interest expenses – taxation expenses)/revenue x 100 = NPM
Gauging Your Startup’s Profitability
As we mentioned above, profit margins are a strong and accurate indicator of your small business’s overall profitability. Once you’ve performed a few profit margin calculations over time, you can compare their results. This will help you to determine whether or not your business is reaching its goals, meeting your expectations, and maintaining a high or growing degree of profitability.
Remember that for many startups in many industries, profitability can take months or even years to achieve. Persistence is the key to success in this regard, and regularly calculating your profit margins can help to reassure you that your business is progressing in an optimal way.
It’s also useful to calculate your profits if you’re aiming to expand your business. The better your profits, the more opportunities you will have to invest in your startup’s expansion, even during times of persistent inflation.
What is an Ideal Profit Margin for a Startup?
A strong profit margin will vary from business to business, and from industry to industry. For instance, if you work in the digital entertainment industry, you may spend a few years building your company’s profit margins up to 15%.
The question to ask here is not whether this is a good profit margin in general, but whether it is good when taken in the context of your industry and sector. If the average profit margin for digital entertainment startups for the year stands at 18%, then you can consider your profit margin to be relatively strong.
Once you have your profit margin figure, it’s helpful to compare it to your industry standard to see how your startup is faring. If its profits are lagging behind those of its competitors and you’re battling with growth, investigate ways to minimize your operational expenses to improve them.
Methods to Improve Your Profit Margins
If you run the numbers and find that your startup’s profit margins are lacking, there are many ways to improve them.
The first is to increase the prices of your products and services. This is a complex method that requires research into whether or not it’s viable. Your specific customers may not continue to buy your products if you raise your selling price. Take into account the demand for your services and products and the current average prices within your industry to determine whether this move will benefit you.
Secondly, assess your existing customer base and find out which of your products are in the highest demand, and whether or not they need more products and services that you could reasonably provide. Expanding your offerings is often a highly effective way to boost your profits and attract new leads.
Thirdly, you could consider simplifying your product or service range. If some of your products sell significantly better than others and this trend has remained true for a period of time, consider removing poor-performing products from your catalog and focus on your more profitable offerings.
Next, assess your marketing strategies and how much you spend on marketing each product your startup offers. Depending on the channels and strategies you’re using, your marketing costs could be unnecessarily elevated.
Investigate more cost-effective methods of reaching your target audience, including inbound marketing methods like social media marketing, PPC advertising, and digital content creation. Using the right marketing channels can dramatically lower your expenses while exposing your brand to a far wider and more targeted audience of potential customers.
If you know how to calculate the profit margin for your startup, you’ve got the tools you need to increase your profits over time.
Once you know how your small business is performing compared to its closest industry competitors, you can take the necessary steps to reduce your operating expenses. This will ensure that you get your profit margins to exactly where they should be.