Many business owners focus heavily on sales. More customers, more invoices and higher turnover can make a business look like it is growing. But growth does not always mean the business is becoming more profitable.
A business can increase sales and still make less money if profit margins are falling.
That is why reviewing profit margins regularly is essential. It helps you understand whether your pricing, costs and operations are actually producing the return your business needs.
What is a profit margin?
A profit margin shows how much profit your business keeps from its sales after costs are taken into account.
There are different types of profit margin, but two of the most important are:
- Gross profit margin — sales minus direct costs.
- Net profit margin — profit after overheads and other business costs.
In simple terms, your profit margin tells you how much of each pound of income is left as profit.
Why turnover does not tell the full story
Turnover is the total amount your business earns from sales.
It is important, but it does not show whether the business is actually making enough profit.
For example, a business could increase turnover from £500,000 to £700,000 but also see wages, supplier costs, rent, marketing and software costs increase at the same time.
If costs rise faster than income, the business may be busier but not better off.
This is one of the most common problems in growing businesses.
Why margins fall
Profit margins can fall for several reasons, including:
- Supplier price increases
- Staff cost increases
- Discounting too heavily
- Underpricing work
- Poor stock control
- Inefficient processes
- Rising overheads
- Unprofitable customers or projects
- Not reviewing prices regularly
Small changes can have a large impact over time.
A 2% or 3% reduction in margin may not seem serious at first, but across a full year it can make a significant difference to profit.
Why regular margin reviews matter
Reviewing profit margins regularly helps you identify problems early.
It allows you to ask:
- Are prices high enough?
- Are direct costs increasing?
- Are certain services less profitable?
- Are some customers costing too much to serve?
- Are overheads reducing overall profitability?
- Is growth actually improving the business?
Without this information, business decisions become guesswork.
Pricing should not be set and forgotten
Many businesses set prices once and leave them unchanged for too long.
But costs rarely stay the same.
If supplier prices, wages, rent and software costs increase, your pricing may need to change too.
Regular margin reviews help you understand when price increases are needed and where adjustments should be made.
The danger of discounting
Discounting can win work, but it can also damage profit.
If your margin is already tight, even a small discount can remove most of the profit from a job, product or service.
Before offering discounts, business owners should understand the impact on profitability.
Sometimes, it is better to lose low-margin work than stay busy with customers who do not generate enough return.
Gross margin versus net margin
Gross margin focuses on direct costs.
Net margin looks at the final profit after all costs.
Both matter.
A strong gross margin may still lead to weak net profit if overheads are too high. Equally, a low gross margin can make it difficult for the business to cover normal operating costs.
Reviewing both gives a clearer picture of business performance.
How bookkeeping affects margin reporting
Accurate profit margin reporting depends on accurate bookkeeping.
If costs are coded incorrectly, invoices are missing or expenses are entered late, your reports may not show the true position.
Good bookkeeping allows you to see which areas of the business are profitable and which need attention.
Poor bookkeeping means you may not spot falling margins until the year-end accounts are prepared.
What business owners should review each month
A monthly margin review should look at:
- Sales by service or product
- Direct costs
- Gross profit margin
- Overheads
- Net profit
- Pricing changes
- Supplier increases
- Customer profitability
- Work that took longer than expected
This does not need to be complicated, but it does need to be consistent.
Final thoughts
Profit margins show whether your business is truly performing well.
Turnover may tell you how busy the business is, but margin tells you whether that activity is worthwhile.
By reviewing margins regularly, business owners can price more confidently, control costs, protect profitability and make better decisions.
At Merranti Accounting, we help businesses understand their numbers properly through accurate bookkeeping, management accounts and practical financial advice.
Written by Steve Watts
