5 ways growing startups can improve their net income margin

Today, investors pay keen attention to a startup’s sustainable profitability. To build for the long-term, it’s important for founders and CFOs to focus on expanding margins, rather than only cutting costs. Unlike growth, which tends to be loud and celebrated, margin is subtle. But its an essential part of growing a business, and understanding how to increase net income margin can make a big difference. 

Here, we’ll explain what a good net income margin looks like and share five ways that growing startups can strategically increase this metric. 

The net income margin (also known as net profit margin) is the amount of profit a company has left over after all expenses have been paid. 

Here is a simple formula for net income margin:
Net income margin = Net income ÷ Revenue

As an example, imagine a supply-chain company that generates $20 million in revenue and $2 million in net income. Their net income margin is 10% ($2 million ÷ $20 million). Therefore, the company pockets 10 cents of profit for every dollar of revenue. 

In addition to net income margin, there are other key margin metrics financial leaders need to understand, including gross margin and operating margin. Here’s a brief overview of each.

Remember, the net margin captures everything, including the cost of goods sold (COGS), operating expenses (OpEx), taxes, and interest. A main benefit of calculating the net income margin is that it can be the clearest indicator of a company’s overall financial well-being.

What’s considered a good net income margin varies, depending on several factors, including the business model, the stage of the business, and the industry. But, as a general guideline, companies with net income margins between 7% and 10% are considered to have healthy margins. 

Here are a few examples of what a good net income margin looks like for different types and stages of startups:

• Early-stage or pre-seed: Often, early startups start with negative margins because they’re heavily invested in product development or customer acquisition.
• Series A to Series B startups: These startups are scaling and likely  starting to improve operational efficiency and sustainable growth, but they could still have negative or slightly above break-even net income margins.
• Inventory-based businesses: Businesses that require physical inventory may have slimmer net income margins. For instance, startups in the retail sector may see margins ranging from 2% to 5%. But efficient-growth startups with healthy financial habits may see higher net income margins ranging from 5% to 15%.
• Mature-startups: Mature startups, such as SaaS companies, could achieve higher margins of 10% to 20% because they have lower operating expenses and can scale easily.

To put things into perspective, your startup’s goals shouldn’t be about aiming for perfection. Instead, focus on making incremental improvements along the way. 

Let’s explore five strategies that growing startups can try to increase net income margin.

1. Improve gross margin before cutting OpEx

Making an effort to reduce operating expenses makes sense, but it can only get you so far. A more effective strategy to build sustainable profitability is improving your company’s gross margin. 

Although this task may be challenging for lean startups, there are several tactics finance leaders should consider implementing, including:

• Securing better pricing on vendor contracts
• Reducing unnecessary expenses from COGS
• Negotiating lower payment processing fees
• Optimizing spending on cloud infrastructure 
• Auditing fulfillment or logistics costs

Applying these strategies could help your startup to see small improvements in gross margin, which may have a positive ripple effect throughout the business. 

2. Eliminate operational drag, without slowing growth 

Tedious tasks, overlapping subscription tools, and time-consuming administrative work, can cause productivity and decision-making to slow down. But, when startups prioritize margin expansion, it may help combat operational inefficiency.

Start by assessing the subscription services you’re paying for. Identify any overlapping tools that could be consolidated to reduce duplication and eliminate high costs. Also, review any manual finance workflows, which require extra headcount. Determine how to leverage the technology you have at your disposal to automate processes that could save your organization valuable time and money. 

Making these strategic moves to streamline processes could help control OpEx as revenue grows. 

3. Revisit your pricing strategy 

Reviewing your company’s pricing strategy is one of the most effective ways for finance teams to improve net income margin. 

A mistake new founders frequently make is underpricing products or services when they enter the market, then failing to adjust prices once they’ve built a loyal customer base. To avoid this common misstep, a growing startup could, for example, introduce a 2% price increase, which could meaningfully increase net margin, without making any significant operational changes. 

Here are several other options for startup founders to consider when it comes to pricing power: 

• Value-based pricing adjustments
• Usage-based pricing
• Dynamic pricing based on the season or demand
• Creating premium packages
• Selling annual or multi-year contracts
• Discontinuing heavy discounting
• Optimizing pricing of tiers

Making price changes is a high-leverage move that could influence margins faster than just cutting costs. 

4. Reduce capital and interest costs

Startup founders, especially those that depend on fundraising or financing, often underestimate how their company’s financing structure will affect net income margin. In particular, the cost of interest can discreetly erode net income. 

To improve your startup’s net income margin, you could consider refinancing high-interest debt at lower rates. It’s a good idea to improve cash forecasting to anticipate future needs. 

Additionally, finance leaders can deploy working capital strategically by improving customer payments or negotiating longer payment terms with suppliers. These tactics can help to free up cash — and avoid relying on hefty lines of credit. 

5. Increase financial visibility and forecasting discipline

Dialing in on revenue metrics can be second nature for startup CFOs. But  making sure you have visibility into margins is an important aspect that often goes unnoticed each quarter.

Your finance team can gain financial clarity by tracking margins monthly and testing various scenarios in your financial model. Here are a few approaches worth trying:

• Evaluating customer acquisition costs: Assess the potential impact of rising customer acquisition costs and identify which customer segments could generate the most revenue.
• Setting up real-time expense tracking: Another way to increase financial visibility isto make sure relevant stakeholders have access to real-time spending and effective expense categorization. This will allow your finance teams to see how costs are allocated and, in turn, make necessary adjustments, without waiting until the end of the month. It’s a proactive approach to prevent overspending.
• Tracking team-level profitability: Concentrating on department-level profitability tracking may enable finance leaders to better analyze how each team generates revenue and how the business overall spends money. This can help improve budgets and ensure resources are allocated appropriately. 

When banking, bill pay, cards, and accounting are centralized, founders gain a clear view into real net income performance. With Mercury’s robust platform, you can view all your transactions in real time and gain financial clarity to manage your startup’s margins.

A dilemma financial leaders face is deciding whether to prioritize growth or margin expansion. Although there’s no one-size-fits-all approach, here are a few tips to keep in mind, based on your company’s stage:

• Early-stage startups: Pre-seed startups or those with seed funding should ideally prioritize growth over profitability. The main goal during early stages is to achieve product-market fit and prove that customers are buying your product or services. When founders focus on increasing market share or acquiring new customers, they’re better positioned to attract financing from investors.
• Mid-stage startups: Series A to Series B startups should shift focus towards improving their unit economics. Start by improving gross margins and improving operational efficiency. Margin expansion demonstrates that a business venture can grow sustainably.
• Later-stage startups: Once a later-stage startup is well established, the objective shifts to balancing margin expansion and growth. Mature companies should aim to improve their net income margin, scale revenue, and manage costs effectively. 

In the current environment, investors look for startups with a proven track record of efficient growth. Companies that demonstrate strong margin discipline alongside revenue growth prove to investors that they have long-term viability. 

What is considered a good net income margin?

The ideal net income margin varies depending on a startup’s stage and industry. Early-stage startups may intentionally operate with negative margins as they look to grow, whereas later-stage startups might aim for 10% to 20% margins. 

How do you increase net income margin?

Startup teams can improve net income margin by increasing  their gross margin, improving productivity, reassessing their pricing strategy, reducing capital costs, and centralizing their financial data to improve forecasting. 

What causes low net income margin in startups?

Low net income margins could stem from a variety of factors. This includes operational inefficiencies, high COGS, research and development investment, low pricing strategies, or heavy marketing spending.

Is a 10% net profit margin good?

Yes, a 10% net profit margin is generally viewed favorably across many industries, since it shows a company’s profitability and operational efficiency. 

What’s the difference between gross and net margin?

Gross margin measures profit minus COGS and focuses on production efficiency. Net margin reflects overall profitability after all expenses (COGS, OpEx, interest, and taxes) are accounted for.