We get it. Questioning your profit margin typically starts by feeling the squeeze of having enough cash flow to cover your monthly bills or not having enough revenue to pay yourself each month. When these red flags show up, you should deep dive into your profit margin and determine if you are charging enough for your services.
Profit margins are one of the simplest financial ratios for service-based businesses. Net profit margin is a measure of how much money is making on its services after subtracting all of the direct and indirect costs involved. It is expressed as a percentage and is calculated by dividing the net profit by the revenue and multiplying by 100.
For example, you own a cleaning company with monthly revenues of $10,000. After all your expenses, including employee wages, you have a net income of $1,000. This means your profit margin is 10%. A reasonable profit margin for a cleaning company is around 10 to 28%. You can increase your profit margin to be as high as 50% or more as your business grows.
Service based businesses typically have high profit margins and low startup costs, making them incredibly profitable.
How do you know if your prices are too low:
- Your competitors’ prices are much higher.
- Conduct a price analysis of your competitors pricing. If you find that your prices are significantly lower, that typically indicates you are underpricing (and undervaluing) your services.
- Even though competing on price can be a strategy that attracts clients when you are first starting out, it is not sustainable in the long run and may eventually lead customers to think your services are low quality.
- You have a high demand or never get rejected.
- Taking it back to Economics 101, demand if proportional to price. When prices are low, demand is typically high.
- Never receiving rejection to your quotes means your pricing is too low. Rejections are a good thing and ensure you are being paid your worth. On the other hand, too many rejections could mean your pricing is too high.
- Low profit margins and cash flow problems.
- If you are noticing your profit margins are constantly low or negative, it is a clear indication that your prices are too low. Low profit margins means you are not generating enough revenue to cover expenses, which leaves little opportunity to reinvest in your business and grow.
- If your business experiences cash flow issues, it can be an indicator that your pricing will not support daily operations or employee wages.
Ways to increase your net profit margin
- Conduct a cost analysis.
Evaluate your cost structure to make sure your pricing is covering all your expenses, including your pay if you are setup as an LLC, while providing a reasonable net profit margin. Compare this cost structure to average rates of your competitors to determine if prices can be adjusted to achieve a sustainable balance.
- Communicate your value.
Make sure you are clearly communicating your value to your customers. Be sure to highlight your expertise, what makes you different from the competitors, and the solutions you provide to your customers pain points. Clearly displaying your value will help to justify higher prices to potential customers. This also builds trust with your target audience, which is always helpful to be paid what you are worth.
- Find upsell opportunities.
Listening to your customers needs and pain points will help you to identify additional areas where you can offer premium services that address their specific challenges. You can also create tiered service packages, bundle services, offer add-ons, or create limited-time promotions. These don’t need to be a long-term play but can help increase profit margins while also serving your customers in additional ways.
Finding the correct pricing strategy is an ongoing process. Keeping an eye on the critical net profit margin percentage will help guide you as you find a balance between competitive pricing and valuing your services. Finding that balance will ensure the long-term success and profitability of your business.
Want to deep dive into your net profit margin or explore ways you can increase your profitability?