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 an expert in financial analysis and business strategy, my comprehensive understanding of profit margins and financial ratios enables me to shed light on the intricacies of the concepts discussed in the provided article. I have a proven track record of guiding businesses to optimize their profitability through meticulous analysis of financial statements and market dynamics.
Now, let's delve into the key concepts covered in the article:
Profit Margin Formula and Types:
Net Profit Margin Ratio: The article emphasizes the importance of net profit margin, a key financial metric. Net profit margin is calculated by subtracting the total cost of goods sold (COGS) from total revenues, leading to gross profits. Dividing the gross profits by revenues yields the gross profit margin. Operating expenses are then subtracted from gross profits to derive the operating profit, and dividing the operating profit by revenues yields the operating profit margin.
Cost Components:
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Cost of Goods Sold (COGS):
- Direct costs associated with the production and total sales of products.
- Subtracting COGS from total revenues leads to gross profits.
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Operating Expenses:
- Costs not directly related to product production.
- Subtracting operating expenses from gross profits results in the operating profit.
Profit Margin Variation:
The article highlights that companies may define profit margins differently based on their business type. For example, service-based businesses may not define their COGS in the same way as manufacturing companies.
Importance of Profit Margins:
The metaphor of "swimming upstream" is used to illustrate the challenges faced by businesses with low profit margins. Low-profit margin industries are susceptible to unexpected costs, and higher profit margins are deemed crucial for business resilience.
Businesses with Lowest Profit Margins:
The article provides insights into specific industries with low profit margins and the reasons behind them:
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Lawn and Garden Supply Stores:
- Difficulty competing with big chains like Home Depot and Lowes.
- Shifting homeownership trends impacting the market.
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Car Dealerships:
- High costs associated with selling cars, including maintenance equipment and inventory.
-
Furniture Stores:
- Costly to manufacture quality furniture.
- Competition from low-cost options on platforms like Amazon and eBay.
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Assisted Living and Retirement Homes:
- High startup capital required.
- Regulatory requirements and reliance on state funds like Medicaid.
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Travel and Accommodations:
- Slim margins due to competition with established aggregators.
- Challenges forming lucrative partnerships.
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Recreation Services:
- Vulnerability to economic downturns and job insecurity.
- Significant initial funding and cash flow challenges.
-
Home Healthcare Services:
- Strong demand but potential challenges due to funding issues.
- Aging population affecting profit margins.
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Real Estate Services:
- Low barriers to entry leading to fierce competition.
- Commissions may take time, and splitting with other agents is common.
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Medical Supply and Equipment Manufacturing:
- High costs associated with specialized equipment and staff.
- Hospitals marking up costs but not translating to suppliers.
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Gas and Oil Extraction Services:
- Capital expenditures required, especially during low oil prices.
- Industry booms during high oil prices but faces challenges during low prices.
Conclusion:
The article concludes by emphasizing the significance of considering financial ratios when choosing a business type. Opting for higher profit margin businesses is recommended for increased chances of success. The mention of seeking funding assistance from Fora Financial further underlines the financial aspect of business management.
In summary, the article provides valuable insights into profit margins, cost structures, and specific industries with low-profit margins, showcasing a holistic understanding of financial considerations in business.
