Profit margin
June 16, 2004

Q:  I own a childcare center and am looking for a loan to expand. My banker asked me what my profit margin was and I was embarrassed to tell him that I have no idea. How would I compute this? -- Maria, Galveston, Texas

A:  As a concept, profit is easy to understand. It is the difference between what it costs you to make or buy your product and what you earn when you sell it. To figure out your profit margin, you need to first compute your gross and net profit.

Gross and Net Profit. The gross profit on a product sold, or service rendered, is computed as the money you brought in from the sale, less the cost of the goods sold (COGS.) Your COGS is the costs you actually incur in making the product or service. For a product, it will include raw materials, labor, and other directly associated costs. For a product you sell, it is your wholesale costs

Net profit is your gross profit less taxes and interest. Net profit is same thing as earnings or net income.

To calculate your profit margin requires that you first compute your monthly gross profit. Let’s take your childcare center for example. To compute your gross profit, you must figure out your total costs to take care of each child, such as

Rent

Labor

Food

Insurance

Utilities

Advertising

Auto

Other

Let’s assume that your total overhead every month is $5,000. If you have 10 children, then, obviously, your expenses per child would be $5,000 divided by 10, or $500 per child. That is your break-even point per child per month.

Let’s further assume that you bring in $8,000 a month, meaning that you charge $800 a month per child ($800 x 10 children = $8,000.) Your gross profit therefore, per child, is $300, and your total gross profit is $3,000.

Profit Margin. While your gross profit is expressed as a dollar amount ($3,000), your gross profit margin is a percentage, computed as follows: Gross Profit divided by Sales equals Gross Profit Margin. In the example above, the gross profit would be $3,000 divided by $8,000, or 37 percent. That is good. Any business that makes 37 percent profit is doing something right.

Markup: While we’re at it, let’s figure out your markup as well because your banker will want to know this number too. Like your gross profit margin, your markup is also expressed as a percentage: Sales Price minus Cost to Produce divided by Cost to Produce. In the case of the childcare center it would look like this: $8,000 (sales price) minus $5,000 (cost to produce) equals $3,000. $3,000 divided by $5,000 equals 60 percent. So the markup for the childcare center is 60 percent, again, quite impressive.

Not only will your banker want to know this but figuring out these numbers help you analyze your business better. These computations can be done on any part of your business, thereby helping you figure out what areas bring the best return on your time, money, and efforts.

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Today’s Tip: Do you qualify for a business loan? The SBA offers this quiz to find out:

1. Do you have a good credit history? ( ) Yes ( ) No

2. Are your taxes up to date? ( ) Yes ( ) No

3. Can the business repay the loan? ( ) Yes ( ) No

4. Does the business have equity? ( ) Yes ( ) No

5. Does the business not have a lot of debt? ( ) Yes ( ) No

6. Do you, the owner, have your own money invested in the business? ( ) Yes ( ) No

7. Does the business have collateral? ( ) Yes ( ) No

8. Would you be willing to personally guarantee the loan? ( ) Yes ( ) No

9. Do you have a solid management team? ( ) Yes ( ) No

10. Do you have a business plan? ( ) Yes ( ) No

Scoring: According to the SBA, unless you answered yes to all questions, you may have a hard time getting a business loan.

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