Ever have one of those months where sales look pretty good, but you check the bank account and think, where did all that money go?
It happens to a lot of small businesses.
You can have plenty of customers, decent revenue, and a busy team, yet still not have much left over at the end of the month. Usually, there is a reason. Costs may have crept up, prices may not have kept pace, or small expenses may have quietly piled up.
That's where profit margin analysis comes in.
Instead of looking only at sales, you look at how much of that revenue you're actually keeping.
Start With What You're Actually Keeping
Let's say your business brings in $200,000 in sales.
That sounds good, but $200,000 isn't your profit.
Maybe $120,000 goes toward inventory, labor or other direct costs. That leaves $80,000 as your gross profit. Then you have payroll, rent, insurance, software, advertising, and everything else involved in running the business.
Maybe you're left with $20,000.
So you made $200,000 in sales but kept $20,000. Your net profit margin is 10%.
The calculation is straightforward:
Net profit ÷ revenue × 100 = net profit margin
It's also useful to look at your gross profit margin, which shows what's left after the direct costs associated with your products or services.
Neither number tells the whole story on its own. Together, they give you a much better financial performance analysis.
Your Income Statement Reporting Can Be A Useful Starting Point
If you want to find out where money is leaking, your income statement is one of the first places to look. Don't just check the final profit figure and move on.
Look at what changed:
- Did revenue go up?
- Did the cost of sales go up even faster?
- Has payroll increased?
- Are you spending more on advertising?
- Did a bunch of new software subscriptions appear?
- Are professional fees higher than usual?
This is how income statement reporting empowers businesses. You're not reviewing the report just because it's part of your accounting routine. You're looking for changes that might need an explanation.
For example, maybe revenue is up 15% from last year, but profit is only up 3%. That's worth investigating.
Perhaps suppliers raised their prices. Maybe you're offering larger discounts. Maybe payroll has grown faster than expected.
More Sales Don't Always Mean More Profit
It's easy to assume that higher sales automatically mean a healthier business. Not necessarily.
Imagine you pick up an extra $50,000 in sales but those sales require more staff, more materials, more shipping, or bigger discounts.
By the time those costs are covered, there may not be much left. That's why gross margin deserves some attention.
If your gross margin is falling, ask what's changed.
- Maybe a supplier increased prices.
- Maybe you haven't raised your prices in a couple of years.
- Maybe customers are negotiating more aggressively.
- Maybe one particular product has become much more expensive to deliver.
This is one area where profit margin analysis can reveal something that revenue numbers hide.
Compare Your Budget With What Actually Happened
If you have a budget, use it. Don't create one at the beginning of the year and forget about it.
Budget vs actual analysisis simply a comparison between what you expected to happen and what actually happened.
Say you planned to spend $4,000 a month on marketing but ended up spending $6,500. That doesn't automatically mean the extra $2,500 was wasted. Maybe the campaign brought in a lot of new business. But if sales stayed flat, you probably want to know why.
The same goes for payroll.
If you budgeted $15,000 but spent $19,000, find out what happened. Was there overtime? Did you hire someone with higher expertise? Were bonuses paid? Or was the original budget simply unrealistic? You may even want to consider outsourcing payroll to an expert for better insights.
A difference between budget and actual results isn't necessarily a problem. It's a signal. It tells you where reality didn't match the plan.
Watch the Small Expenses
Big expenses are easy to notice while the smaller expenses are easier to ignore.
A $50 software subscription doesn't seem like much. Neither does a $75 membership or a few extra delivery fees. But add those costs together over a year and they can become a surprisingly large number.
Go through your recurring expenses every so often. Ask yourself:
- Are you still using all those subscriptions?
- Are there services you're paying for twice?
- Have bank or payment processing fees increased?
- Are there memberships nobody uses?
These are the kinds of things that can show up during regular financial report analysis for small business.
You're not necessarily looking for one huge mistake. You're looking for costs that keep adding up without giving the business much in return.
Look at Expenses as a Percentage of Sales
Dollar amounts can sometimes be misleading. Suppose payroll goes from $40,000 to $50,000. That sounds like a major increase.
But if revenue went from $100,000 to $200,000 at the same time, payroll is actually taking up a smaller percentage of your sales. That's why it's helpful to look at major expenses relative to revenue.
Check payroll as a percentage of sales. Do the same with advertising, direct costs, rent, and other significant expenses.
You don't need a complicated system. You're simply trying to understand what's normal for your business.
Once you know your usual numbers, unusual changes become easier to spot.
Don't Confuse Profit With Cash
Here's another issue that catches business owners off guard. A business can be profitable and still have cash-flow problems.
Suppose you invoice customers $40,000 this month. That's revenue, but if those customers haven't paid yet, you don't actually have that $40,000 available in your bank account.
Meanwhile, payroll still needs to be paid. Suppliers want their money. Rent is due.
That's why cash flow reporting needs to be part of your regular review. Look at how much cash is actually coming in and going out.
Pay particular attention to accounts receivable aging. If customers are consistently taking 60 or 90 days to pay, you may have a cash problem even if your income statement looks healthy.
Sometimes improving cash flow isn't about making more sales. It's about collecting the money you're already owed.
Keep an Eye on Unpaid Invoices
While you're looking at cash flow, check your outstanding invoices and accounts receivables.
How much is currently due? What's 30 days late? What's 60 days late? What's been sitting unpaid for months?
If overdue invoices keep growing, it's something worth addressing.
Maybe invoices need to go out sooner. Maybe deposits would make sense for larger jobs. Perhaps your payment terms need updating, or customers simply need more consistent follow-ups.
It sounds basic, but getting paid on time can make a noticeable difference.
You don't always need another sale to improve cash flow.
Sometimes you need to collect the money from the sales you've already made.
Look for Trends, Not Just One Bad Month
One unusual month doesn't necessarily mean something is wrong. Maybe you paid an annual insurance bill or bought a new equipment. Maybe sales were slow because of seasonality.
That's why it's better to compare financial reports from different periods. Look at this month versus last month. Compare the same period with last year when possible. Check year-to-date results. And compare actual numbers with your budget.
You're looking for patterns. If advertising costs have increased every month while sales haven't changed much, that's worth investigating. If gross margins have been falling for several quarters, that's also worth investigating.
Your Books Need to Be Accurate
There's not much point in analyzing financial reports if you have messy bookkeeping.
Missing transactions, incorrect expense categories, unreconciled accounts, and outdated invoices can all make your reports misleading.
You might think your expenses are too high when they're simply categorized incorrectly. Or you could think margins have improved because some costs haven't been recorded yet.
Keeping everything current can also become difficult as the business grows. If bookkeeping is taking up too much of your time, bookkeeping services for small business can help keep the records organized and up to date.
Once your books are in good shape, financial reporting services can make it easier to turn those records into useful reports.
Financial Performance Analysis With AccountiPro
At the end of the day, profit margin analysis is about understanding what happens between making a sale and actually keeping the money.
At AccountiPro, we help you prepare the main financial reports that every business requires, be it the Income Statement, Cash Flow Statement or Balance Sheet. We also perform variance analysis to help you determine reasons for differences between actual results and budgeted expectations.
If you want an in-depth profit margin analysis, contact us today so that we may guide your business to financial success.
