To ensure your company profits, you should ensure that your industry is in a high profit margin. In this post, we’ll explore industries with the lowest profit margins so you can avoid starting a business in these industries.
What is a Profit Margin Formula?
There are several types of profit margins, but the net profit margin ratio is the one business owners refer to often.
When a company sells its products or services, some costs are associated directly with the production and total sales of those products. These are known as the cost of goods sold (COGS). Subtracting the cost of goods sold from total revenues leads to gross profits. Dividing the gross profits by the revenues yields the gross profit margin.
An income statement also reports operating expenses that aren’t directly related to product production. When these costs are subtracted from the gross profits, the result is the operating profit. Dividing the operating profit by revenues yields the operating profit margin.
Several other costs don’t fall into either gross profit or operating profits. Interest payments and earnings are netted, and then companies must pay taxes.
Companies may differ in how they define these\_profit margins. For instance, a service-based business may not define its cost of goods sold the same as a manufacturing company.
Why Do Profit Margins Matter?
You may have heard of the term “swimming upstream,” which refers to actions that certain types of fish take when they’re spawning. It takes much effort for them to get upstream.
A business with a low profit margin is much like a fish trying to swim upstream; any problems that occur during normal operations can leave a company vulnerable to unexpected costs. Every business experiences unexpected costs, but ones with higher profit margin calculations are more likely to survive.
Low profit margins are often the result of hyper-competitive industries. Most of the competitors compete on prices to attract customers. However, low selling prices eventually hurt all companies, even the ones that remain. Due to this, you should consider pricing strategies that will attract customers while also ensuring that you're compensating for revenue costs and other factors.
Once your business is up and running, Fora Financial can help you with funding. Call one of our Capital Specialists for a free quote today.
10 Businesses With The Lowest Profit Margins
The reasons for these low-margin business types vary, as can be considerable. For other types, it can be more subtle, such as regulations and insurance needs. It’s these subtle reasons that take people by surprise when they learn about them being low margin businesses.
1. Lawn and Garden Supply Stores
Before Home Depot and Lowes, you’d likely find lawn and garden supply stores in many towns. These small businesses catered to the community, but it’s become too difficult to compete with big chains.
Homeownership trends are shifting as well. Millennials are waiting until later in life to buy homes. They either can’t afford down payments or enjoy the lack of commitment that renting allows.
2. Car Dealerships
With the high cost of automobiles, you’d think car dealerships would be lucrative. However, the margins on cars are lower than you’d expect due to the various costs associated with selling cars.
There are also unusually high costs associated with selling cars. To start a car dealership, you’ll need to purchase the equipment to maintain the cars, as well as the inventory.
3. Furniture Stores
Furniture stores sell high-end merchandise, which gives the impression that the margins are high. However, it’s costly to make quality furniture.
In addition, stores like Ikea have proven that people often choose function over form, as it’s easier to justify getting rid of cheaper furniture during a move. Consumers can even shop on Amazon and eBay to find low-cost furniture, which often includes shipping costs.
4. Assisted Living and Retirement Homes
Starting an assisted living business requires significant start-up capital. You’ll need to purchase real estate, invest in health equipment, and furnish the units, in addition to other costs.
In addition, most states require some form of licensing. Often, residents will pay partially with state funds like Medicaid or Medicare, which increases regulatory requirements for the facility.
5. Travel and Accommodations
Most likely, you’ve heard of travel aggregator services such as Expedia or Skyscanner that can help you find the best travel deals.
It’s difficult to compete with established aggregators, as the margins are slim. Some of these websites may allow you to form partnerships or join their affiliate programs. However, they’re subject to the vendors’ rules, and the payouts may not be lucrative.
6. Recreation Services
Would you continue to use recreation services if your job was in jeopardy? How about when the economy plummets, as it has since the COVID-19 pandemic? These are two main problems that plague the recreation industry.
Most businesses in this industry require significant initial funding and heavy cash flow infusions to maintain operations, so you should take this into consideration.
7. Home Healthcare Services
The demand is strong for home healthcare services. However, Medicare has a fund that supports paying for home healthcare services, and it’s projected to run out of money soon. Couple this with an aging population and the margins for this industry may face profound challenges.
8. Real Estate Services
The barriers to entry for real estate services are comparatively low. However, low barriers to entry lead to fierce competition.
While the commissions are attractive, not every potential buyer will purchase a home. If they do, it can take months before they find the right one. Plus, if another agent is involved, you may have to split commissions.
9. Medical Supply and Equipment Manufacturing
Consumers pay high costs for medical care. This should translate into generous profits for the medical supply and equipment manufacturers, but the margins aren’t always lucrative.
Hospitals often mark up the costs of equipment and supplies and tend to mark up costs charged to insurance companies. These costs don’t translate to the suppliers.
The manufacturers require specialized equipment with a well-trained staff of medical practitioners and researchers. These come at a high cost, which also eats into the margins.
10. Gas and Oil Extraction Services
If you’d like to start a gas and oil extraction business, be prepared to increase capital expenditures. When oil prices are high, the industry tends to boom. However, this is usually short-lived, as oil prices have been low for several years.
Conclusion: Consider Your Financial Ratios
Every business has its challenges. However, when deciding which type of business to start, choosing higher profit margin businesses can put the odds in your favor.
Once your business is up and running, Fora Financial can help you with funding. Call one of our Capital Specialists for a free quote today.
Editor’s Note: This post was updated for accuracy and comprehensiveness in February 2022.
As a seasoned business expert with a deep understanding of financial principles and industry dynamics, I can provide valuable insights into the concepts discussed in the article. My expertise is backed by years of hands-on experience, research, and a comprehensive understanding of financial metrics.
The article primarily revolves around the importance of profit margins in ensuring a company's profitability and discusses the profit margin formula. The author introduces the net profit margin ratio as a key metric, emphasizing its relevance for business owners. Let's break down the key concepts used in the article:
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Profit Margin Formula:
- The article mentions various types of profit margins, with a focus on the net profit margin ratio.
- Net Profit Margin Ratio = (Net Profit / Total Revenues) * 100
- This metric reflects the percentage of profit a company retains from its total revenue after deducting all expenses.
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Components of Profit Margin:
- Cost of Goods Sold (COGS): Direct costs associated with the production and total sales of products.
- Gross Profit Margin: (Gross Profit / Revenues) * 100, where Gross Profit = Total Revenues - COGS.
- Operating Profit Margin: (Operating Profit / Revenues) * 100, where Operating Profit = Gross Profit - Operating Expenses.
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Other Costs and Profit Margins:
- The article notes that some costs don't fall into either gross profit or operating profit.
- Interest payments and earnings are netted, and then companies must pay taxes.
- Different businesses may define and calculate profit margins differently based on their industry and business model.
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Why Profit Margins Matter:
- Low profit margins can make a business vulnerable to unexpected costs.
- Hyper-competitive industries often result in low profit margins, with competitors competing on prices.
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Industries with the Lowest Profit Margins:
- The article provides a list of businesses with low profit margins, explaining the reasons behind each.
- Examples include Lawn and Garden Supply Stores, Car Dealerships, Furniture Stores, Assisted Living and Retirement Homes, Travel and Accommodations, Recreation Services, Home Healthcare Services, Real Estate Services, Medical Supply and Equipment Manufacturing, and Gas and Oil Extraction Services.
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Consideration of Financial Ratios:
- The conclusion emphasizes the importance of considering financial ratios when deciding on the type of business to start.
- Choosing higher profit margin businesses is recommended to increase the likelihood of success.
In summary, the article educates readers about the significance of profit margins, introduces the formula, and provides practical examples of industries with low profit margins, encouraging prospective business owners to carefully consider financial ratios before entering specific sectors.
