Apple’s net income margin last year was 21.1% and their pre-tax margin was 28.0%.
Walmart’s net income margin last year was 2.0% and their pre-tax margin was 3.0%.
Some businesses have hefty profit margins (like Apple)… and others have skinny margins (like Walmart).
The $1,000,000 question
Do you know what your profit margin is?
Are your profit margins better than the average business… or worse than average?
And maybe the larger question is: are you are satisfied with your profit margin?
For purposes of this discussion, I’m defining net income margin as net income after all expenses are deducted (including income taxes) divided by revenues. Pre-tax margin is defined as profit after all expenses are deducted (except income taxes) divided by revenues. Let’s focus on your pre-tax profit margin.
Grab your P&L and divide your pre-tax profit for the most recent year by revenues. For example, if your pre-tax profit last year was $1,000,000 and your revenues for that year were $5,000,000 then your pre-tax profit margin is 20%. Jot that number down.
Salary vs. profit: don’t mistake the two
Before I ask the question about whether your pre-tax profit margin is good or bad, we need to talk about the very common mistake business owners make when judging the adequacy of their profits (and profit margins).
In the fantastic book Simple Numbers, Straight Talk, Big Profits, author Greg Crabtree says:
“Remember this key distinction: You get paid a salary for what you do, and you get a return on what you own. Why is this so important? Because when you don’t pay yourself a market-based wage, your net income number is lying to you. Or rather, you are lying to yourself.”
This is a very important point if you work in your business AND own the business.
If you work in the business and own it… you wear two hats.
One hat you wear is as an employee/manager. This is the role where you get paid (or should be paid) a salary for the work you do. The salary you receive for your role as an employee should be shown as an expense on your P&L just like any other payroll expense you have.
The other hat you were is as the owner/investor. This is the role where you receive (or should receive) dividends or distributions of excess cash from profits. The profits of your business are computed AFTER deducting all the payroll required to run the business – including your salary and related benefits.
Adjust for below-market owner salary/compensation
Let’s use our example where your business does $5,000,000 in revenues and your pre-tax profit is $1,000,000. You work full time (and more) in the business but your salary/compensation is only $100,000. Let’s assume that a market-based salary, what you would have to pay someone similarly qualified to run the business, is $225,000.
In this case your true profit is really $875,000, or 17.5%. You must adjust for the below-market compensation, so it does not distort your true profitability.
Are you satisfied with your profit margin?
Now to the question of whether your profits are as high as they should be. There are a couple ways to evaluate this question?
The first, is to look at whether your profit margin has been going down or going up over the last three years. A declining profit margin trend is a sign that you have a problem that needs to be addressed.
Another approach to evaluating your profitability is to look at publicly available company and industry data of profit margins. You can look at a variety of industries and companies to get a better sense for what profit margins are in similar companies (or even different companies). The more you know about what other businesses generate the more informed you are as you evaluate your own profit margins.
I created an interactive dashboard (shown above) to give you access to profitability margins by industry.
You can enlarge the dashboard by clicking in the bottom right corner. And you can move to each page in the dashboard by clicking near the bottom center of the report. You can also click here to see an enlarged version of the dashboard.
The dashboard shows profitability margins across 94 different industries and for all companies combined. There are over 7,200 companies included in the industry averages.
The super-short video below shows you have the interactive profitability dashboard works.
How does your profitability compare to other businesses?
I encourage you to compare your profitability (and your profit margins) to the industry data in the dashboard.
Comparing your profitability with other businesses gives you a sense for whether your business is as profitable as it should be (or could be).
It is not an exact science, or a perfect apples-to-apples comparison. But it gives you a general sense for whether you need to focus on driving your profitability and cash flow higher this year. You can see a more in-depth discussion of the profitability dashboard here.
And this short video walks you through the 5-minute profitability assessment so you can quickly assess whether your profit margins are above average or below average.
Are you ready to improve your profitability? Download our ebook to learn how to confidently grow your profits and cash flow.