Understanding Profit Margins: The Key to Small Business Success
In this article, we’re diving into profit margins—what they are, why they matter, and how understanding them is the real key to building abundance.
Before you tune out, hear me out. Profit margins are one of the most important metrics in your business, and yet they’re often overlooked—especially by small business owners. There’s a common belief that if there’s cash in the bank, everything’s fine. But true power comes from understanding your numbers. Knowing your profit margins—and learning how to improve them—is where the magic really happens.
What is a Profit Margin?
Put simply, your profit margin measures how efficient your business is at making money.
There are three key types of profit margins (which we’ll get into shortly), but first, here’s what you need to know:
A healthy business clearly shows where income comes from, where money is being spent, and whether your expenses are dragging down your bottom line. All of that is connected to your profit margins.
My goal for you is to make more money for the same amount of work—or less. That’s not just about revenue. It’s about how efficiently your business turns revenue into actual profit.
Understanding Efficiency
When I talk about efficiency, I mean how well your business converts revenue into profit. Profit margins give you a factual, measurable way to assess performance.
Your profit margin is a percentage—showing how much of your revenue turns into profit. The higher the percentage, the more efficient your business is.
A common mistake is thinking that if your revenue doubles, your profit does too. But if your expenses have increased even more, your actual profit—and your profit margin—might be shrinking. That’s when it’s time to look at financial bloat and make smarter business decisions to get your margins back on track.
Calculating Your Gross Profit Margin
Let’s look at an example. Say you run an e-commerce business. You buy a product for $3 and sell it for $15. That $3 is your direct cost.
If you generate $10,000 in revenue and spend $5,000 on direct costs, you’re left with $5,000 in gross profit. To calculate your gross profit margin, divide the profit by the revenue, then multiply by 100.
In this case:
$5,000 ÷ $10,000 = 0.5
0.5 × 100 = 50%
This means you’re earning 50 cents of gross profit for every dollar of revenue.
People often ask me, “What’s a good margin?” And while it depends, as a general rule:
For product-based businesses, aim for a gross profit margin of at least 50%. For service-based businesses, you should be aiming for 80% or higher.
We go much deeper into this inside my Magic by Numbers program—where I break it all down using real-life examples. I’ll drop the link below if you’re keen to learn more.
Calculating Your Operating Profit Margin
Once you have your gross profit, the next step is to subtract your operating expenses. These might include rent, salaries, subscriptions, electricity, software, etc.
Using our previous example:
Gross profit = $5,000
Operating expenses = $3,000
Operating profit = $2,000
To calculate the operating profit margin:
$2,000 ÷ $10,000 × 100 = 20%
So your operating profit margin is 20%.
The Net Profit Margin
Finally, we look at net profit—what’s left after paying tax.
In Australia, the small business company tax rate is currently 25%. So, if you have $2,000 in operating profit, and you pay $500 in tax, you’re left with $1,500 in net profit.
That’s a 15% net profit margin:
$1,500 ÷ $10,000 × 100 = 15%
This is why tax planning matters—reducing your tax (within legal limits) increases your net profit margin and leaves more money in your pocket.
Final thoughts
There are three types of profit margins:
Gross profit
Operating profit
Net profit
As a baseline, aim for at least a 50% gross profit margin.
Then ask yourself:
Can I generate more cash without increasing workload?
Can I reduce expenses by switching suppliers or increasing order quantities?
Can I raise my prices?
Hopefully, this article has given you a clearer understanding of what profit margins are, why they matter, and how to start improving yours—so you can build a business that’s profitable, sustainable, and deeply aligned.
See you in the next post—I’m looking forward to connecting again soon.
Activity:
If you use Xero, go to the top banner and click on ‘Accounting’, then select ‘Profit and Loss’. This will give you a breakdown of your gross and operating profit.
Xero doesn’t calculate your profit margins as percentages, but you can do this manually using the examples above.
Net profit is a little harder, as Xero doesn’t include tax automatically—but don’t worry too much about that for now. The key is to start familiarising yourself with your gross and operating profit figures.
Curious to to learn more and dive even deeper? listen to my free (and secret) podcast.
