Optimizing your small business income and expenses is critical to survival and growth. Getting your expenses under control means you generate greater profits that you can invest into growing your business further or bolstering your own bank account.
It’s also useful to compare your expenses with other small businesses. These “average” expenses vary widely by industry, but it’s still a helpful benchmark to understand how you’re doing. We’ll answer your questions and explore what percentage of income “should” go to expenses.
Is There an Average Expense Percentage for Small Businesses?
There’s no straightforward answer to this question. Expenses as a percentage of revenue vary according to the industry you’re in, the types of products and services you sell, and many other external factors. With all of these caveats, a general percentage for all your costs, expenses, and taxes might be 90 percent as an average, with 95 percent being bad, and 80 percent being good. This does vary very widely.
Is There an Average Percentage by Type of Small Business?
We can get more insight into expense percentages if we focus on businesses in particular sectors. Patriot Software suggests that average percentage expenses for types of business, including all costs and taxes, are as follows:
- Construction: 95% of revenue goes to expenses and taxes, leaving 5% profit.
- Hotels and accommodation: 92% of revenue goes to expenses and taxes, leaving 8% profit.
- Restaurants: 85% of revenue goes to expenses and taxes, leaving 15% profit.
- Retail: 95% of revenue goes to expenses and taxes, leaving 5% profit.
- Transportation: 81% of revenue goes to expenses and taxes, leaving 9% profit.
Chron suggests expense percentages for other industries.
- Accountants and bookkeepers: 82% of revenue goes to expenses and taxes, leaving 18% profit.
- Attorneys and legal services: 83% of revenue goes to expenses and taxes, leaving 17% profit.
- Real estate agents: 85% of revenue goes to expenses and taxes, leaving 15% profit.
- Physicians: 86% of revenue goes to expenses and taxes, leaving 14% profit.
- Grocery stores: 97.5% of revenue goes to expenses and taxes, leaving 2.5% profit.
How Are Business Expenses Related to Profit Margins?
Your business expenses and profit margins have a direct relationship: a profit margin is the amount of money your business makes after you have deducted your business expenses. For example:
- Your business has $100,000 in annual sales.
- Your total combined expenses add up to $80,000.
- Your profit margin is 20%.
- Your expenses are 80%.
Simply deduct your profit margin percentage from 100% to get your expense percentage, and vice versa.
How Are Business Expenses Calculated?
There are various ways to work out what your business expenses are. One way to understand this is by exploring how businesses calculate their profit margins. There are three main types of profit margin:
- “Gross Profit Margin” factors in the cost to make an item or provide a service.
- “Operating Profit Margin” takes the gross profit margin and adds in other expenses not directly related to making a product or providing a service.
- “Net Profit Margin” takes the operating margin and adds in expenses like tax and interest, to find the final bottom line.
What Does the Gross Profit Margin Mean for My Expenses?
Your gross profit margin is the total revenue that your business takes in, less “Cost of Goods Sold,” which is effectively the amount of money you spend specifically to produce goods or provide services. This typically means:
- Costs of materials and manufacturing.
- Costs of salaries that you pay to employees directly involved in producing products or providing services.
Gross profit margin does not take into account “indirect” expenses like rent, utilities, and other overheads.
This means the expenses associated with your gross profit margin only take into account how much it costs to directly produce the product or service. You wouldn’t normally use this measure to calculate your overall profit margin or expenses, but it can be useful in understanding the expenses and profits involved in making individual products.
What Does the Operational Profit Margin Mean for My Expenses?
Your operational profit margin takes into account all of the operational expenses in your business to work out how much profit you’ve generated. This includes:
- Costs of materials, manufacturing, and salaries of people involved in directly producing goods and services, as per gross profit margin.
- Costs of logistics, distribution, and other expenses incurred in getting goods to customers.
- Costs for all other staff and contractors, including administration, research and development, sales, marketing, operations, and other areas.
This means your operational expenses include the overall cost of running your business and day-to-day operations. Your operational profit margin does not include debt, taxes, interest, and some other non-operational expenses.
What Does the Net Profit Margin Mean for My Expenses?
Your net profit margin is what’s left after you’ve paid all of your operating expenses and taken into account the taxes you owe, debt you have, loans, and interest you’ve paid. It’s effectively the amount that you can reinvest into the business, pay out as bonuses, or otherwise use outside day-to-day operations.
What Do These Profit and Expense Percentages Tell Me About My Business?
- Gross profit margins and associated expenses tell you how efficiently you’re producing each item, and whether you’re selling for the right price.
- Operational profit margins and associated expenses tell you about the financial health of your business as a whole. For long-term sustainability, your overall operational expenses need to be lower than your revenue.
- Net profit margins and associated expenses tell you how much you will have left after meeting all of your commitments and taxes, and that money can be used to invest further and grow.
Your expenses and profit margins are essential to understanding the financial health of your business. Once you understand what they are, and how you compare to others, you can focus on bringing your expenses down and maximizing profit.