What’s A Good Profit Margin For An eCommerce Business? (3 BIG Things You Need To Know)
Joy Sharma
No matter what kind of products you sell online, every eCommerce business has one clear goal: To maximize cash flow and boost profit margins.
However, for small business owners and entrepreneurs, understanding what constitutes a good profit margin can be a challenge. That’s because determining a “good” profit margin really comes down to the structure of your business and your long-term goals. For example, if you’re happy with your current cash flow, then achieving a profit margin that comfortably covers your operating expenses might be a good place to start. On the other hand, if you’re goal is to scale your online store and grow your operation, you need a strategic plan that allows you to expand your profit margins to meet your growth needs.
Not only that, but there are actually multiple types of profit margins that store owners need to be concerned with, and if you’re not focusing on the right metrics, you could be wasting your resources by trying to increase the wrong margins. So, understanding the different profit margins, what they mean for your business, and how to improve them is a crucial component of running your business.
In this blog, we’ll cover the top 3 things that every eCommerce business owner, even those who use dropshipping, needs to know about profit margins, plus how to use this information to your advantage.
#1: What Is A Profit Margin?
#2: What Are The Different Types of Product Margins?
- Gross Profit Margins
- Operating Margins
- Net Profit Margins
- Pro Tip: Use A P&L Statement To Your Advantage
#3: How To Find A Good Shopify Product Margin?
- Ad Spend
- CODs
- Profit
- Opex
Shopify Product Margin FAQs
#1: What Is A Profit Margin?
Whether you studied business in school or you’re a self-made entrepreneur, you probably have a general idea of what a profit margin means for your business. But if you want to get ahead of the competition, having an in-depth understanding of this metric can give you a huge advantage. So, let’s start with the basics…
What is a profit margin, anyway?
Simply put, a profit margin is a way to measure how much profitability a particular product or service has for your business. Unlike other metrics like total revenue or net sales, profit margins don’t use specific dollar amounts. Instead, this metric is shown using percentages. So, the higher your percentage is, the more profitable your business becomes.
With that in mind, there are some types of businesses that naturally have higher profit margins than others. In most cases, businesses with lower operating costs and high consumer demand will have higher profit margins than businesses with extensive costs and a great deal of competition.
In the retail world, businesses with high-profit margins include things like…
- Jewelry
- Apparel
- Luxury Vehicles
- Software
- Video Games
- Medical Equipment
- Pharmaceuticals
These products often have a high demand from consumers and can typically reduce their costs during the manufacturing process.
On the other end of the spectrum, businesses with lower profit margins might include…
- Restaurants
- Transportation Systems (Airlines, Taxis, etc.)
- Agricultural Goods
All of these businesses involve a great deal of manual labor, which equates to higher operating costs for their owners. They also may be subject to extensive regulations, which may drive these costs up even higher.
Similarly, the eCommerce world also has certain types of businesses that produce higher profit margins than others. In our experience, the most profitable online businesses tend to be…
Consumer Packaged Goods
Consumer packaged goods, or CPGs, are products that are consumed by the customer on a daily basis. This tends to make them profitable since the customers regularly repurchase these items, and, most of the time, these products can be produced for relatively low costs. Examples of profitable CPG include things like skin care products, coffee, supplements, makeup, and other household products.
Subscription Services
Another type of eCommerce business that tends to be highly profitable is subscription-based services. Like the previous examples, these businesses have relatively low operating costs and staffing needs because they operate completely online. Some examples of this might include things like SaaS tools, online courses, and other recurring memberships.
#2: What Are The Different Types of Profit Margins?
Now, it’s important to know that not all profit margins are created equal. In fact, there are 3 types of profit margins that can give you a unique perspective into the profitability of your business, especially for small business owners.
Gross Profit Margins
This type of profit margin is used to measure the difference between the total sales revenue of a product and its adjacent COGs or cost of goods. Depending on the type of products you’re eCommerce store is selling, some of the COGs included in your gross profit margin calculations might be:
- Raw materials
- Manual labor
- Packaging
Essentially, gross profit margins are a good way to determine the profitability of each individual product you offer since the costs of production can vary greatly between different goods. For instance, the cost of producing surgical equipment is very different than the costs associated with producing new software products. Either way, you’ll want to use gross profit margins to make strategic decisions about particular items in your online store. This is also a great tool to use when developing pricing strategies, allowing you to create more profitability by increasing the selling price of certain goods.
To find the gross profit margin for a product, start by calculating the COGs for your product and subtracting it from your net sales. Next, take the number you found and divide it by the original net sales total. This will leave you with a percentage of your gross profit margin.
Operating Margins
Similarly to gross profit margins, operating margins also help you measure the difference between the cost of producing a particular product and the net revenue you receive in return. However, operating margins also include fixed costs in the equation, meaning that the COGs for this particular profit margin are much higher. Fixed costs include the things you need to run your business, even if they aren’t directly related to the product of one singular item. For example, some fixed costs are:
- Rent
- Utilities
- Employee pay
- Warehouse costs
Most of the time, operating margins are used to determine how strong your profitability is in comparison to other online businesses selling similar products. So, if your operating margins are significantly higher than your top competitor, you’ll know that your business is operating effectively. If not, you may want to find new ways to eliminate unwanted expenses.
To find your operating profit margin, follow the same formula as your gross profit margin but with the inclusion of fixed costs into your COGs.
Net Profit Margins
If you want to capture a holistic picture of your store’s profits and overall financial well-being, net profit margins are the best option. This profit margin includes all the production and fixed costs from the first two profit margins, with the addition of other business expenses that you might have missed. By that, we mean things like:
- Taxes
- Interest
- Depreciation
Simply put, your net profit margin is the difference between your net income and the total sales of your store. While this might not help you create specific strategies for your products, net profit margins are a great tool to use when speaking with potential investors or other business partners. That’s because this profit margin provides a “snapshot” of your profitability that can’t be achieved using the previous formulas.
To find your net profit margin, start by determining your entire company’s net income, which is the profit that’s left after all expenses are subtracted from your gross income. Then you can take this result and divide it by the total sales of your business. Finally, take this number and multiply it by 100 to find your profit margin as a percentage.
Pro Tip: Use P&L Statements To Your Advantage
Now, many business owners think that looking at their profit margins alone will be enough to make strategic decisions about their eCommerce operations. However, without connecting your profit margins to your P&L statement (profit and loss statement), you could be missing out on major insight into your business’s expenses that could drastically improve your profits.
We offer a template for both daily and monthly P&L reports, but the monthly statement will be the best for evaluating your profit margins. In this report, we use three primary formulas.
Gross Profit = Total Revenue – Cogs
This formula is used to find your gross profit, which is how much money you make before deducting other expenses.
Operating Profit = Gross Profit – Operating Expenses
Next, we use a formula that allows us to see the amount of money you make after taking away expenses besides your fixed costs, like office supplies, software integrations, and more.
Total Net Income = Operating Profit – Non-Operating Expenses + Non-Operating Income
Finally, it’s time to find your net income before taxes.
After using all three of these formulas, you can start finding strategic ways to maximize your profit margins by identifying the main variables that impact your profitability and determining which ones need to be optimized to create a high-profit margin.
For a monthly P&L sheet, these categories include:
1. Gross Sales / Operating Revenue
You can think of your Gross Sales, or Operating Revenue, as the most integral component of your P&L statement, which is why it usually appears on the top line. Operating revenue shows the amount of money made from a business’s main operations, which for eCommerce businesses means selling goods online.
Keep in mind that this also includes discounts, returns, and refunds, so it might not offer a slightly distorted view of your overall growth potential. That’s why we use a few different revenue definitions when looking at this variable.
Order Revenue = Total Sales + Returns
This definition is mostly used for marketing departments because returns are not typically a reflection of ineffective marketing efforts.
Total Sales = Order revenue – Returns
Conversely, this is a more accurate definition for the business end of your operation since it shows you how much returns or refunds are impacting your revenue.
Net Sale = Total Sales – Shipping – taxes
For eCommerce businesses, this is by far the most important definition of revenue, and it should always alight with your net sales number in the Shopify store.
2. Variable Cost
Unlike fixed costs, variable costs may fluctuate based on the company’s operations. In other words, your variable costs will be much greater when there is an increase in demand for your products, leading to more production. On the other hand, it will decrease will you see a lull in consumer demand for your goods. Some of the variable costs associated with your store might be:
Cost of Goods (COGs)
As we’ve mentioned, COGS are the expenses that are most directly related to the production of a particular product or service and are used to determine the product price of any given item.
Forward Shipping
This includes all the costs associated with getting a product out of your warehouse and to your customer’s doorstep.
Merchant + Payment Processing Fees
This is the weighted average of the fees collected by the payment processors you use, like PayPal, Stripe, and other merchant fees from eCommerce platforms like Shopify and Amazon.
3. Gross Profit
Gross profits show you the amount of money you earned before any deductions, making it an extremely useful tool when creating a pricing strategy for your product. For example, you may decide to markup your product if you see an opportunity for growth from this number. Or, if you have excess inventory you need to unload, you can use it to determine a good sale price.
Additionally, gross profits can be used to determine how well your products are performing compared to the industry averages in your eCommerce niche. Although regardless of what type of goods you’re selling, 70% is considered a healthy gross profit.
4. Ad Spend
Your ad spend includes the collective costs associated with the marketing budget, including running ads on social media platforms like Facebook and TikTok, optimizing your eCommerce store for SEO purposes, and more.
6. Profit
Finally, the last line on your P&L statement is your overall profit, typically referred to as your bottom line. On average, a good ratio for an eCommerce business to have would be 4:1 for revenue: profit.
Ultimately, connecting your profit margins to your P&L statement allows you to take the insight gained from your calculations and create effective strategies for maximizing your profits. For example, if you find that you aren’t receiving a good ROAS from your marketing efforts, you could recalibrate your marketing budget to align with your goals. It also allows you to connect the dots between all of your other key eCommerce metrics, like the conversion rate for your ad campaigns and the AOV (average order volume) of your site in the Shopify app store.
Of course, this is just a general overview of how a P&L statement can be leveraged to improve the profitability of your Shopify store. If you have to take a deeper dive into this topic, along with a built-in template that makes evaluating your P&L variables quick and easy, check out our in-depth guide here:
#3: How To Find A Good Shopify Product Margin?
No matter what type of products you sell in your eCommerce store, there are a few main targets you should be trying to maintain for a good profit margin. That being said, it’s important to remember that these targets are specific to businesses that are earning less than 10 million dollars in revenue per year.
Obviously, once you pass the 10 million dollar threshold, your targets will change drastically, and you’ll begin to include other factors like brand equity into your equation. Until then, this is the model we recommend following to track your profit margins and achieve your long-term growth goals.
Ad Spend: 40%
First, let’s look at your ad spend, which should account for 40% of your total revenue. This includes all the costs associated with your marketing efforts, including direct-to-consumer advertising, influencer marketing, and other costs that might come from trying to increase organic traffic to your store.
CODs: 35%
Next, you have your CODs or cost of delivery. This is similar to COGs because it includes all the variable costs associated with producing a specific product. Still, it also includes the expenses used to deliver the product to the consumer, like packaging, shipping costs, and warehouse storage if you use it. This should account for 35% of your total revenue.
Profit: 15%
Now, in this model, profit refers specifically to your net profit, which is the profit you actually take home after all your other expenses have been deducted. Typically, this will account for around 15% of your total revenue.
Opex (Operating Expenses): 10%
Finally, your operating expenses include all the costs of running your business, fixed and variable. This number should be around 10% of your total revenue.
How To Use These Targets To Increase Profit Margins
When you combine all of these factors together, you have 100% of your total revenue. So, you can start to look at these targets and determine if your revenue is being used effectively or not.
For instance, let’s say that your ad spend is significantly lower than the 40% used in this model. That’s an indication that you might not be advertising your products as well as you should be, leading to a decrease in your profit margins.
At the same time, you might find that your operating expenses are much higher than they should be, causing you to move money away from important variables like your ad spend and CODs. In that case, you should start looking for ways to decrease the costs of running your business by finding more affordable ways to produce products or eliminate unnecessary expenses.
Even though this model is geared toward businesses currently earning less than 10 million in revenue, we believe that if you maintain these targets, you will be able to earn a substantial amount of money for your store and streamline your path to growth. Ultimately, our goal is to help you surpass the 10 million dollar threshold and start earning the kind of income that your brand deserves.
Shopify Profit Margin FAQ’s:
“Where should I start if I want to increase my profit margins?”
We understand that profit margins come with a lot of complex information, including a handful of equations and calculations you’ll need to follow. That’s why we recommend following the steps in this article to ensure you don’t miss a single piece of insight for your business.
“What if I don’t have a P&L template?”
Using a good P&L template is essential to improving your profit margins because it connects the dots between your expenses and their impact on your profits. To do this effectively, check out our free P&L template and in-depth instructional guide here:
“How long will it be until these strategies improve my margins?”
We’re confident that your margins will steadily increase if you follow these strategies. But if you’d like to streamline your efforts and achieve faster results, connect with a member of our team to learn how we can bring our revenue goals to life.