Sales are up on last year. The team is flat out. But when you look at the bank account, there isn’t much more profit to show for it. If that sounds familiar, you’re not alone, and it’s usually fixable.
To improve profit margins in a small business, start with price, then your cost of sales, then wages and overheads, in that order. Small changes to price usually move profit the most, because every extra dollar goes straight to the bottom line. This guide shows you where margin leaks, which lever to pull first, and a worked example with real numbers.
In short:
- Know your gross margin for every product, service, customer or job, not just for the business as a whole.
- Price is usually the biggest lever. A small price rise often lifts profit more than a bigger cut in costs.
- Discounts, scope creep and supplier increases you haven’t passed on quietly eat your margin.
- Wages and overheads matter, but review them after price and cost of sales.
- Check your margins every month, not once a year at tax time.
What is a good profit margin for a small business?
A good profit margin depends on your industry. A café, an electrical contractor and a software business all run very different numbers, so comparing yourself to a general average won’t tell you much.
There are two margins worth tracking:
- Gross profit margin: what’s left from sales after the direct costs of delivering your product or service, such as materials, stock and direct labour.
- Net profit margin: what’s left after every cost, including wages, rent, insurance, software and everything else it takes to run the business.
The quickest way to see how you compare is the ATO’s small business benchmarks. They cover 100 industries and show typical ranges for cost of sales, labour and total expenses as a share of turnover, based on tax return data. If your cost of sales sits at the high end of the range for your industry, that’s the first place to look.
Why do profit margins shrink as a business grows?
Margins rarely drop in one big hit. They slip a little at a time while everyone is busy. The most common causes we see are:
- Prices that haven’t been reviewed in a year or more, while costs have kept rising.
- Discounts that started as one-offs and became permanent.
- Scope creep, where extra work gets done but never invoiced.
- Supplier price rises that were absorbed instead of passed on.
- Wages growing faster than sales, often from staffing for the busiest weeks all year round.
- A handful of customers, jobs or products that lose money and drag the average down.
None of these show up clearly in a year-end tax return. They show up in monthly reports that break profit down by product, service, customer or job.
Which lever moves profit the most?
For most businesses, price moves profit the most. A well-known McKinsey study of large companies found that a 1% price rise, with sales volumes unchanged, lifted operating profit by about 8% on average. That was a bigger effect than a 1% cut in direct costs or a 1% lift in volume (McKinsey, The power of pricing).
The same maths works for smaller businesses. Here’s an example.
Say your business turns over $4M a year. Your cost of sales is 70% of turnover ($2.8M), which leaves a gross profit of $1.2M. Overheads, including wages outside of direct labour, rent and running costs, come to $1M. That leaves a net profit of $200,000, or a 5% net margin.
Here’s what a 3% improvement in each lever does to that profit, with everything else unchanged:
| Change | New net profit | Change in profit |
|---|---|---|
| Starting point | $200,000 | None |
| Prices up 3% | $320,000 | +60% |
| Cost of sales down 3% | $284,000 | +42% |
| Sales volume up 3% | $236,000 | +18% |
| Overheads down 3% | $230,000 | +15% |
A 3% price rise adds $120,000 in revenue with no extra cost, so all of it lands as profit. Selling 3% more brings in the same extra revenue, but you also pay for the materials and labour to deliver it, so far less of it reaches the bottom line.
That doesn’t mean you should only raise prices. It means price deserves your attention first, because it’s usually the lever that’s been ignored the longest.
How to improve your profit margins in 7 steps
- Find your margin by product, service, customer or job. A single business-wide margin hides the winners and losers. Set up your reporting in Xero or your job management software so you can see gross margin for each line.
- Review your prices. Check every price against your current costs at least once a year, and again whenever a major cost goes up. Most owners are surprised how long it’s been.
- Tighten discounts and scope creep. Write down who gets a discount and why. Make sure variations and extra work are quoted and invoiced, especially in trades and project work.
- Work on your cost of sales. Get quotes from other suppliers, ask for volume pricing and cut waste. Compare your cost of sales to the ATO benchmark for your industry.
- Track wages as a share of revenue. Watch it monthly. If it’s creeping up, look at rosters, overtime and how well staff time matches demand.
- Fix or let go of unprofitable work. Reprice it, change how you deliver it, or stop doing it. Losing a customer who costs you money can lift profit straight away.
- Review overheads every quarter. Software subscriptions, insurance, rent, phones and vehicles add up. Cancel what you don’t use and renegotiate what you do.
How do you raise prices without losing customers?
Most customers accept a fair price rise when it’s explained clearly and handled well. A few practical rules help:
- Give notice. Thirty days is reasonable for most businesses.
- Explain what’s changed, such as higher supplier, wage or insurance costs, in one or two plain sentences.
- Start with new customers and new quotes, then move existing customers across.
- Raise prices regularly in small steps rather than rarely in big jumps.
- Talk to your biggest customers personally before the change.
- Watch your numbers for the next few months so you can see the real effect.
If you’re worried about losing work, run the numbers first. In the example above, the business could lose around 9% of its sales volume after a 3% price rise and still make the same profit as before.
How often should you review your profit margins?
Every month. Margin problems are easier and cheaper to fix when you catch them early. A monthly report that shows gross margin by line, wages as a share of revenue and your cash position gives you time to act before a bad quarter turns into a bad year.
An accountant shows you what already happened. A CFO shows you what to do next.
That’s the gap our CFO packages fill. Our clients see an average 29% lift in profit after working with us. Results vary, and it always starts with clear monthly numbers.
Common questions
What’s the difference between gross and net profit margin?
Gross profit margin is your sales minus the direct costs of delivering them, shown as a percentage of sales. Net profit margin is what’s left after all costs, including overheads. Gross margin tells you if your pricing and delivery work. Net margin tells you if the whole business works.
How do I calculate my profit margin?
Divide your profit by your revenue and multiply by 100. If you made $200,000 net profit on $4M of sales, your net profit margin is 5%. Use gross profit instead of net profit to work out your gross margin.
Is it better to cut costs or raise prices?
For most businesses, a small price rise lifts profit more than a similar cut in costs, because the extra revenue costs nothing to deliver. The best results usually come from doing both: pricing properly and keeping cost of sales and overheads under control.
When should a small business get help with profit margins?
Get help when sales are growing but profit isn’t, when you don’t know which products, customers or jobs make money, or when pricing decisions are made on gut feel. Our Comprehensive Business Review shows you where margin is leaking and what to fix first.
Want to know where your profit is leaking?
Book a free call with our team. We’ll talk through where your numbers are today and the first places to look. If you’d rather start on your own, download our free Run your business with Complete Financial Clarity Excel template.
Related reading
- How much to set aside for BAS each month
- When do you need a virtual CFO? 7 signs it’s time
- Hospitality wages as a percentage of revenue: a guide
- Preparing a business for sale: what buyers check
This article is general information only and doesn’t take your circumstances into account. Speak with a qualified adviser before making decisions.
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