The golden rule (write it on your wall, your hand, your forehead if you have to!):
Turnover = vanity, profit = sanity
Cash is king, right? Only, to have cash on hand in your business, you need to be turning a decent profit and not be too heavily reliant on the bank.
That’s not easy - particularly in hospitality and retail. But it is possible, and made a lot easier to track providing you understand the basics of profitability.
If you’re just getting into this industry, you’ll doubtless have lots of questions about how to become - and remain - profitable. But if you’re an experienced owner, you’ll also know that it’s all-too-easy to forget about the intricacies of profit, and how to mitigate cash flow risk.
Let’s get into it.
What is a profit margin?
This isn’t a stupid question (there’s no such thing). After all, it’s scarily easy to start a business and begin trading without fully understanding how you’ll make money.
It all comes down to your profit margin. This is the percentage of revenue you get to keep after all of your outgoing expenses have been paid. It can be calculated at any time, but is most commonly reviewed monthly, quarterly and for your fiscal end of year.
Your profit margin will also help you work out how much income you’re really making on every dollar or pound of sale. For example, if you’re achieving a 35% profit margin, you’ll have a net income of £0.35 for every £1 of sales.
Keeping a close eye on this figure will help you accurately assess business performance and the health of your operation. It’ll also help you plan, budget and invest safely in the business.
The difference between net, gross and operating profit
There are three main ways to look at your profit margin:
Net profit: sometimes referred to as the ‘bottom line’, this is the total revenue that’s left after you’ve accounted for all expenses.
Calculation: Net Profit Margin = (Net Income / Revenue) X 100
Gross profit: this is what you have left after account for the cost of goods sold (COGS). Profit margins exclude overheads like rent and utilities and are easier to calculate than net profits, because there’s less to account for.
Calculation: Gross Margin = [(Total Revenue - COGS) / Total Revenue] X 100
Operating profit: this takes into account all overheads, sales expenses, administrative costs and anything else that is necessary for the day-to-day running of the business. It excludes debt, taxes and any non-operational expenses. It’s designed to show you your earnings from operating activities.
Calculation: Operating Profit Margin = (Operating Income / Revenue) X 100
Now we understand the mechanics of profit margins, let’s consider how to calculate them in two key hospitality sectors: hotels and restaurants.
How to work out your hotel’s profitability
A healthy profit margin is essential for a hotel to grow and compete against the big chain competition. It’s thought that UK hotels have, on average, around a 32% gross operating profit margin, which really isn’t too shabby.
Here are the simple steps you’ll need to take in order to work out your hotel’s profitability.
Step 1: Look at your expenditure
It’s vitally important that you get a handle on how much your hotel spends on the everyday essentials. There’s the obvious stuff - staff labour and electricity, but there’s also the elements which are easily overlooked.
For instance, how much does it really cost to clean a room? What products are being used which need regular replenishment? What about laundry - how much are you paying the supplier for that service? And don’t forget those OTAs! How much do you spend on average on commission?
Every month is different in the hotel world but pick a typical month without surprises and determine every single cost you encounter.
Step 2: Calculate rooms booked
Work out your average monthly price per room. Then, look at the number of rooms booked and determine the gross profit from the rooms (see the guide above for the formula for this).
Why work with averages? Because hotel room pricing fluctuates regularly and there are usually discounted deals to account for, too, therefore the average will give you the most meaningful profit figure from which to work.
Step 3: Subtract
Now, subtract the total expenditure per month from the average income you’re making on rooms.
This will provide a profit margin for the month. If it’s negative, you’re losing money on every room sale. If it’s positive, you’re making a profit. Simple.
The number you settle on might come as a bit of a shock. But that’s ok, because you know what it is now, and that means you can work hard to maximise that profit margin.
Look for ways to increase direct bookings (circumnavigating the OTAs will help immeasurably with your profit margin). Remember that rooms left empty aren’t just wasted space - they’re a missed opportunity to increase your profit margin.
It’s also important to look historically at your hotel’s profit margin performance. This will help you identify peaks and troughs which can then be planned for in the future.
How to work out your restaurant’s profitability
Most successful restaurateurs will agree that your net profit margin will provide the clearest picture of what’s going on in the business.
It’s thought that the average restaurant profit margin sits somewhere between 2-6%, but it’s possible to achieve net margins of 20% upwards if you run a particularly tight ship.
The simplest way to do this is to work from the following formula:
Net Profit Margin = Net Income/Gross Sales x 100
Your net income can be calculated by taking your gross revenue for any period and deducting operating expenses. Remember that gross revenue in restaurants is derived from all sales of food, drinks, and any additional services of products such as merchandise.
As for operating expenses, these are the costs you incur every day, from the cost of ingredients to the rent, wages, depreciation, utilities and taxes.
There are a few things you can do to increase your restaurant’s profit margin, including:
- reduce the overall cost of food by working closely with your suppliers and focusing on portion control;
- decrease your overheads by using energy-efficient equipment, reducing wastage and incentivising employees to reduce staff churn; and
- use technology to your advantage to balance the books and run a super-efficient operation.
Maintaining a healthy profit margin in any hospitality business is hard work, but ultimately rewarding.
We’ve skimmed the surface today, but this base knowledge of profit margins is absolutely essential if you’re to run a sustainable, growing business.
In fact, we’d recommend revisiting this page in the future whenever you suspect something isn’t quite right, because the answer will often lie in what’s happening with your bottom line.