Turnover is up, the team is busier than ever, and yet there is less left in the bank at the end of the month. Prices across Australia rose 4.3% in the 12 months to September 2026, according to the Australian Bureau of Statistics, and many small businesses are absorbing those costs faster than they can pass them on. You need more sales to make the same money, often at a thinner margin, which is why the place to start when you want to improve profit margins in a small business is the margin itself, not turnover.
The number to fix first is margin, because turnover is what you sell and margin is what you keep. This guide shows you how to calculate gross and net margin, set a target margin, compare your costs against ATO benchmarks, rework the largest costs, and price for value when customers are watching every dollar.
Quick answer: To improve profit margins in a small business, calculate your current gross and net margin for each product or service line, set the target margin the business needs, compare your cost ratios with the ATO small business benchmarks for your industry, reduce or restructure your largest costs first, and review prices for value rather than volume. Then track gross margin every month so you see any slippage within weeks.
What is a profit margin?
A profit margin is the share of each sales dollar your business keeps as profit, shown as a percentage. There are two versions worth knowing, and Business Queensland defines both with these formulas:
- Gross profit margin (%) = (Gross profit ÷ Total revenue) × 100. Gross profit is sales minus the direct cost of the goods or services you sold, so this margin shows whether each sale is priced and delivered profitably.
- Net profit margin (%) = (Net profit ÷ Total revenue) × 100. Net profit is what is left after every expense, including overheads, wages, and interest, so this margin shows whether the business as a whole is profitable.
How do you calculate profit margin? A worked example
To see how the two margins differ, take a business with illustrative figures of $800,000 in annual sales, $480,000 in direct costs, and $240,000 in overheads such as rent, administration wages, and insurance:
| Line | Calculation | Amount | Share of sales |
|---|---|---|---|
| Sales | Annual turnover | $800,000 | 100% |
| Direct costs | Materials and delivery labour | $480,000 | 60% |
| Gross profit | $800,000 − $480,000 | $320,000 | 40% gross margin |
| Overheads | Rent, administration wages, and insurance | $240,000 | 30% |
| Net profit before tax | $320,000 − $240,000 | $80,000 | 10% net margin |
That business keeps 40 cents of each sales dollar after direct costs but only 10 cents after everything else, and the gap between the two figures is where the steps below do their work.
Image note: a formula card showing the gross and net profit margin formulas with the worked example beneath. Alt text: “Gross profit margin and net profit margin formulas with a worked example for a small business”.
Why are small business margins under pressure in 2026?
Margins are under pressure because costs have risen on several fronts at once. The ABS reports that housing costs, driven by new dwellings and electricity, rose 5.2% over the year to September 2026, while transport costs rose 8.7%, mainly because of higher fuel prices. Wages, rent, insurance, and materials have also risen, and compliance and regulation add administrative time on top. When costs climb faster than prices, two things happen: each sale earns less, and the business has to sell more to stand still.
Faced with that squeeze, many owners respond by chasing turnover, because more sales feel like progress and are easy to measure. That response is the volume trap: turnover growth on a shrinking margin means the team works harder for the same result, and cash can tighten even as revenue rises. If cash is already tight, our guide to getting your cash flow in order explains how to protect working capital while you fix the margin.
There is also a planning trap. Some owners hold off on decisions in the hope that costs will settle back to earlier levels. Treating today’s cost structure as your baseline, and planning from it, is usually the steadier path.
How to improve profit margins in a small business: 5 steps
With today’s costs as your baseline, the five steps below take you from knowing your numbers to keeping them on track:
- Know your current margin and your target margin.
- Compare your costs against the ATO small business benchmarks.
- Rework your business cost structure, largest costs first.
- Use pricing for inflation that sells value, not volume.
- Track gross margin every month.
Step 1: Know your current margin and your target margin
Improving profit margins starts with two numbers: the margin you earn now and the margin the business needs.
- Your current gross margin. Take last financial year’s figures, or the last 12 months, and calculate gross profit as a percentage of sales. If you sell several products or services, calculate the margin for each one, because averages hide the lines that are losing money.
- Your target margin. Work backward from what the business needs to cover overheads, pay you and any family members who work in the business a fair wage, repay debt, and keep a buffer for tax and lean months. If you are planning to grow, our business advisory for growing businesses can help you set that figure.
The gap between those two figures is the job, because it tells you how far the cost structure, the pricing, or both need to move.
Step 2: Compare your costs against ATO small business benchmarks
Once you have your own figures, compare them with businesses like yours. The ATO publishes small business benchmarks for 100 industries, and the latest set, published on 27 March 2026, covers the 2023–24 income year. Each industry has a range for ratios such as cost of sales to turnover and total expenses to turnover.
Used this way, benchmarks are a health check rather than a target. In an example on the ATO’s Tax, Super + You learning site, a supermarket’s cost of sales came to 88% of turnover against an industry range of 72% to 77%. A ratio well above your industry’s range is a prompt to look closer at pricing, supplier terms, or waste.
The ATO also uses these benchmarks to identify businesses that may be under-reporting income, though it says it never uses the benchmarks in isolation. A result well outside the range is worth understanding before anyone else asks about it.
Step 3: Rework your business cost structure, largest costs first
Once you know the gap, rework the costs that move it most. Start with the largest lines, because a small percentage change there moves the margin more than a large change to a minor expense: with illustrative figures, trimming 3% from a $300,000 wages bill saves $9,000, while cancelling a $1,200 software subscription saves $1,200. Three areas deserve a look, in this order:
- Labour: get the mix right. Labour is usually the first place to look, because for many service businesses people are the highest cost. The question to ask is which work needs to be done by whom, and where. Some tasks need an experienced person on site, while others, such as bookkeeping, scheduling, design, or customer support, may suit a part-time role, an outsourced provider, or a team member working remotely. Getting the mix of roles right can protect both margin and service quality. Whatever mix you choose, any change to roles or hours involves your obligations under the Fair Work Act and the relevant award, so take advice before restructuring.
- Direct costs: review suppliers and waste. After labour, review your top ten suppliers by spend. Ask for updated quotes, check whether volume or early-payment discounts are available, and look for waste in materials, jobs that have to be redone, and work that never gets invoiced, because small leaks across many jobs add up.
- Overheads: question every recurring cost. Subscriptions, leases, vehicles, and insurance renew each year automatically, so list every recurring cost and ask whether each one still earns its place.
If you want a second view on which costs to move first, our business advisory team works through the numbers with you.
Step 4: Use pricing for inflation that sells value, not volume
Costs are only half of the margin; the other half is price. Pricing for inflation means reviewing what you charge so that each sale still reaches your target margin as costs rise, and two pricing methods are worth comparing:
- Cost-plus pricing adds a fixed markup to what the product or service costs you. The method is simple, but markup is not margin: a 50% markup on a $100 cost gives a $150 price and a gross margin of 33%, because margin is measured against the price, not the cost.
- Value-based pricing sets the price from the outcome the customer receives, so the price can move with the value you deliver rather than only with your costs.
The choice matters because, when prices rise, many customers change how they buy. Some choose a cheaper alternative and accept less. Others pay for the best result and buy less of it, choosing two quality pieces rather than a house full of average ones. That second group is good news for businesses that compete on value, so rather than discounting to win volume, consider:
- Raising prices on lines with the thinnest margin, and explaining what the customer receives for the price.
- Packaging services so customers pay for an outcome rather than an hourly rate.
- Trimming the offer to the products or services your best customers value most.
- Adding a yearly price review clause to agreements with regular customers, so your prices move each year with CPI or wage increases, with the wording checked by your adviser before you change your terms.
On the other hand, businesses that ignore their top line while costs rise will find the margin shrinking each year. Reviewing your prices at least once a year, against your target margin, keeps the two in step.
Step 5: Track gross margin every month
Finally, a margin target only works if you check progress, so build three checks into your monthly management reports:
- Gross margin by product or service line, reviewed alongside cash flow.
- Jobs that are finished but not yet invoiced, reviewed alongside the money customers still owe you.
- Supplier price increases and jobs running over budget, so you can adjust your quotes before the next job.
If a line slips, you will see it within weeks rather than at tax time.
Frequently asked questions about profit margins
What is a good profit margin for a small business?
A good margin depends on your industry. Retail, hospitality, and construction operate on very different cost structures from professional services. A more useful comparison is against your own target margin and the ATO small business benchmarks for your industry, rather than a single national figure.
What is the difference between markup and margin?
Markup is profit as a percentage of cost, while margin is profit as a percentage of the selling price:
- Markup (%) = (Profit ÷ Cost) × 100
- Gross margin (%) = (Profit ÷ Selling price) × 100
A product that costs $100 and sells for $150 has a 50% markup but a 33% gross margin, so if you set prices with a markup but measure results as a margin, you can fall short of your target.
Should I raise prices or cut costs to improve margins?
Usually both are worth reviewing. Cost reductions protect margin on every sale, while price increases depend on how your customers value what you offer. Start by calculating the gap between your current and target margin, then test which combination of cost and price changes closes it with the least risk to customer relationships.
How often should I review my profit margins?
Monthly is a practical rhythm for many small businesses. Review gross margin by product or service line in your management reports, and review pricing against your target margin at least once a year, or whenever a major cost such as rent, wages, or materials changes.
Is increasing turnover the best way to grow profit?
Not on its own. Turnover growth on a thin or shrinking margin can increase workload and cash pressure without increasing profit. Growth works best once each sale is priced and delivered at a margin that covers overheads and leaves a profit.
Improve profit margins by starting with two numbers
The first step to improving profit margins in a small business is to write down your current gross margin and the margin you need. Do it for each product or service line this week, and the costs that need to move will become clear.
Every business is different, and tax and business structuring decisions depend on your circumstances, so if you would like help setting a target margin or reviewing your cost structure, chat with us today.
