The Three Margins Every Owner Should Track
Your income statement tells three different profitability stories. Each margin isolates a different layer of your cost structure, and each one answers a different management question.
Gross Margin: Are You Making Money on What You Sell?
Gross margin measures how much revenue remains after subtracting the direct costs of producing your product or delivering your service. It answers a fundamental question: is the core business model viable?
If your gross margin is low, no amount of overhead cutting will save you. You either need to raise prices, reduce material or labor costs, or rethink what you are selling entirely. A service company with a 30% gross margin is spending $0.70 of every revenue dollar just to deliver the work—before rent, marketing, or the owner's salary.
Operating Margin: Is the Business Itself Profitable?
Operating margin subtracts overhead from gross profit. It shows whether the day-to-day business generates enough gross profit to cover the cost of running the company. This margin strips out financial engineering, one-time events, and non-operating items to show core business performance.
A large gap between gross margin and operating margin usually means overhead has grown faster than revenue. This is common in businesses that add staff, office space, or technology ahead of the revenue to support them.
Net Margin: What Actually Lands in Your Pocket?
Net margin is the bottom line. It includes everything: interest payments, one-time gains or losses, and other non-operating items. This is the percentage of revenue that actually becomes profit after every expense is paid.
Net margin matters most for cash flow planning, tax obligations, and business valuation. A buyer evaluating your company will look at net margin trends over three to five years. Consistent, growing net margins signal a well-managed business.
Industry Benchmarks: What's Normal?
Profit margins vary enormously by industry. According to BLS industry data and SBA financial management resources, typical net margins include:
- Restaurants and food service: 3–5% — Razor-thin margins driven by high food costs (28–35% of revenue) and labor intensity. Success depends on volume and controlling waste.
- Construction and trades: 5–10% — Project-based work with variable material costs. Change orders, rework, and poor estimating are the biggest margin killers.
- Professional services: 10–20% — Consulting, accounting, legal, and marketing agencies benefit from low COGS (labor is the product). Margins depend heavily on utilization rates and billing efficiency.
- Retail: 2–5% — High COGS and competitive pricing keep margins slim. Inventory management and shrinkage control are critical.
- SaaS and software: 20%+ — Near-zero marginal cost per customer after development. High gross margins (70–90%) are standard, but heavy R&D and sales spending can reduce net margins during growth phases.
- Healthcare practices: 10–15% — Constrained by insurance reimbursement rates and high labor costs, but stable demand provides consistency.
Why Each Margin Matters for Different Decisions
Tracking all three margins gives you a diagnostic tool for any financial challenge:
- Pricing decisions: Look at gross margin. If it is declining, your prices are not keeping up with cost increases.
- Hiring decisions: Look at operating margin. Can your gross profit absorb another salary without going negative?
- Investment decisions: Look at net margin. Is there enough actual profit to fund the investment, or will you need to borrow?
- Valuation: Buyers and investors focus on operating and net margins. Consistent margins above industry averages command premium multiples.
How to Improve Your Margins
- Audit your COGS line by line. Most businesses have at least 5–10% waste in their direct costs. Renegotiate supplier contracts, reduce material waste, and improve labor efficiency.
- Benchmark operating expenses. If your rent exceeds 10% of revenue or your marketing spend exceeds 12%, investigate whether you are getting adequate return.
- Raise prices strategically. A 5% price increase with zero customer loss drops straight to the bottom line. Test increases on new customers first.
- Eliminate low-margin products or services. Not all revenue is good revenue. If a service line runs at 15% gross margin while your average is 45%, it may be dragging down the whole business.
- Automate repetitive tasks. Software, systems, and process improvements that reduce labor hours directly improve both gross and operating margins.
Sources
- Bureau of Labor Statistics — Industries at a Glance — Industry-specific financial and employment data
- U.S. Small Business Administration — Manage Your Finances — Financial management guidance for small businesses
- U.S. Census Bureau — Annual Business Survey — Revenue, payroll, and profitability data across industries