The short answer. A good profit margin is the one that clears your Minimum Mandatory Profit. Industry averages describe what other businesses kept, not what yours requires. Your required margin funds debt service at about $1.30 of pre-tax profit per $1.00 of principal, closes your Working Capital Gap, and pays you at market rate. Everything above that floor is option.
Why the Average Is the Wrong Benchmark
Search this question and you get a table. Restaurants 3 to 5 percent. Construction 6 to 8. Professional services 15 or more. The numbers may be accurate. They are also useless for running your business, because they average together companies with no debt and companies drowning in it, owners paid at market and owners paid nothing.
A 9 percent net margin can be excellent for one business and fatal for another. The difference is what that business is obligated to produce before it is profitable at all.
Your Number, Computed
Minimum Mandatory Profit is the floor. Take a $2.5 million business.
- Debt service. $150,000 a year in principal payments. Principal is paid with after-tax dollars, so it takes about $1.30 of pre-tax profit for every $1.00. That is $195,000.
- Working capital. The business is $60,000 short of Working Capital Required and needs to close that gap this year. $60,000.
- Owner compensation. The owner pays himself $60,000. Market rate for his job at this scale is $140,000. The $80,000 difference is a real cost the P&L is hiding.
The floor is $195,000 plus $60,000 plus $80,000. That is $335,000, or 13.4 percent of revenue, before this business has a single dollar of real profit. The industry table says 9 percent is healthy. For this business, 9 percent is a $110,000 shortfall dressed up as success.
From Net Margin to the Gross Margin You Price At
Owners price at the gross margin line, so the floor has to cascade through the model. Layer Cake starts with MMP at the top and cascades down to Breakeven Sales Volume. MMP plus Fixed Cost Capacity equals Required Gross Margin dollars. Divide by revenue and you have the Intended Gross Margin percent every price has to hit.
If that same business carries $650,000 in fixed cost, Required Gross Margin is $985,000. On $2.5 million in revenue, every job has to deliver about 39.4 percent gross margin. Not quote it. Deliver it. Anything less and the floor does not clear.
What Sits Above the Floor
Profit by Design is the discipline of engineering a business to keep 15 cents of every dollar it produces by running the company on 85 cents. That is the design target. The floor is the survival line underneath it.
Retirement funding and exit reserves are choices about what to do with real profit once the floor clears. They are not tests of whether profit exists. A business that clears its floor and has not yet funded retirement is profitable. It has options to exercise, not a crisis to fix.
Frequently Asked Questions
Is gross margin or net margin the one that matters?
Both, in order. Net margin against MMP tells you whether the business is truly profitable. Gross margin is where you control it, because that is where pricing lives. Work the floor up through Layer Cake to get the gross margin every job has to deliver.
My margin beats the industry average. Am I fine?
Not necessarily. If your floor is higher than average because of debt, growth, or a below-market owner paycheck, beating the average can still leave you short. Compute your own number.
What if my business has no debt?
Then your floor is lower and your required margin is lower. That is a real advantage. You still need to fund working capital and pay yourself at market rate.
How often should I recompute this?
Any time the cost structure changes: new debt, a rate move, a major hire, a new location, a restated owner paycheck. Every one of those restates MMP and moves the margin you need.