As they strive to grow and become viable, many service-based businesses focus on their revenues and cash flow to measure their progress. However, these two accounting metrics do not reflect a company’s profitability. The profit margin is the most important indicator of performance and overall health for any small business and it’s important to understand how accountants calculate this metric. Here is a guide to determining profit margins for service-based businesses.

A Guide to Profit Margins

What Is a Profit Margin?

Profit margin is the amount of money that a small business makes in earnings off of each dollar of sales. It is a standard way to determine the flow of profits a company is bringing in over a period of time compared with the costs and sales during the same period. While small business owners should pay attention to growing their profit margin as much as possible, it’s important to have a realistic expectation for your industry.

How Do I Determine the Profit Margin for Service-Based Businesses?

While accountants calculate profit margin by dividing your company’s net income by the revenue, there are several factors that need to be considered for service-based businesses to make the metric more accurate. These expenses are different than those used for companies selling tangible products and can increase or decrease the overall profit margin.

Direct costs, which are costs attributed to producing a service, should be considered for service-based businesses. This could include a sales commission payment associated with a project. You should also examine employee salaries, marketing costs, and indirect costs such as rent and utilities.

The accounting team at Simplified Tax Inc, located in Sparta, WI, has over 40 years of experience providing expert business consulting and payroll services to their clients. Give them a call at (608) 269-2633 to speak to a knowledgeable accountant. You can also visit them online to learn more about their tax preparation services.