Quick answer
Profitability measures how efficiently a business turns revenue into profit, usually expressed as a margin: the share of each sales dollar left after costs. Gross margin shows what remains after the direct cost of sales; net margin shows what remains after every expense. Lenders use profitability, together with cash flow and its trend over recent years, to judge whether a business can carry and repay new debt.
Key points
- Profit is a dollar figure; profitability is that figure relative to sales or assets
- Gross margin, net margin and return on assets are the common measures
- ATO small business benchmarks let you compare your costs with your industry
- A profitable business can still run short of cash if customers pay slowly
Two bakeries can each clear $100,000 a year and be in very different shape. One does it on $400,000 of sales, the other needs $1.2m and three times the staff. Profitability is the measure that separates them. It describes how much of each dollar coming in actually stays in the business once costs are paid.
How is profitability measured?
The measures most owners and lenders use are straightforward ratios. Business Queensland sets out the standard formulas:
| Measure | Formula | What it tells you |
|---|---|---|
| Gross profit margin | Gross profit ÷ revenue × 100 | How well pricing covers the direct cost of what you sell |
| Net profit margin | Net profit ÷ revenue × 100 | How much of every sales dollar is left after all expenses |
| Return on assets | Net profit ÷ total assets × 100 | How hard your equipment, stock and property are working |
| Return on equity | Net profit ÷ owner’s equity × 100 | The return on the money the owners have tied up |
Gross profit and net profit each have their own glossary pages. Lenders also lean on EBITDA, which strips out interest, tax, depreciation and amortisation to approximate cash earnings before financing.
How do you know if your margins are healthy?
Margins only make sense against your own industry. Around 100 industries are covered by the ATO’s small business benchmarks, showing typical ranges for cost of sales and total expenses as a share of turnover. The ATO relies on them to flag businesses whose figures look unusual, but owners can use them the other way: if your cost of sales sits well above the range, pricing or supplier terms deserve a look. The ATO itself cautions that benchmarks are a guide and shouldn’t be read in isolation.
Profitable, yet short of cash?
This trips up many growing businesses. Profit is recorded when a sale is made, but cash arrives when the customer pays. A builder with $400,000 of invoices on 45-day terms can show a strong margin on paper and still struggle to meet Friday’s payroll. Stock bought ahead of a busy season does the same thing.
That gap is why lenders look at cash flow alongside profitability, and why our guide on why profitable businesses run out of cash is worth a read. If the gap is a timing issue, check whether short-term funding could bridge it.
How lenders read your profitability
- Banks typically want two years of financial statements showing consistent profit, then test whether that profit covers the new repayment with room to spare. When you fit, they’re often the cheapest money available.
- Non-bank and fintech lenders often care more about the cash moving through your account than the bottom line, which helps businesses with a thin or uneven profit history. See low-doc business loans.
- Property-secured lenders weigh profitability less heavily and focus on the security and a clear plan to repay.
Across all of them, the trend matters. Margins improving year on year tell a better story than a single strong result.
Worked example: a family bakery
Here’s an illustrative case. A Ballarat bakery turns over $620,000 a year. Ingredients and packaging cost $217,000, so gross profit is $403,000, a gross margin of 65%. After wages, rent, power, insurance and other overheads of $341,000, net profit is $62,000, a net margin of 10%.
The owner wants $90,000 for a second oven and display cabinets. A lender would add back $14,000 of depreciation and a one-off $6,000 legal bill, giving about $82,000 in adjusted earnings to cover the new repayments plus existing debt. A margin and markup calculator shows how a small price rise on the best-selling lines would lift that cushion further.
Related terms
- Operating expenses: the overheads that separate gross from net profit
- Add-backs: adjustments lenders make to reported profit
- Debt service coverage ratio: whether earnings cover repayments
- Cash flow: the timing side of the story profit doesn’t show
Turning a good margin into the right loan
If your business makes money but the bank wants more history, more security or more time than you have, you’re not out of options. We look at the full picture, including margins, cash flow and any property you could offer.
An enquiry takes about sixty seconds. Asking us leaves your credit record untouched, because no check is run at this stage. Your details aren’t shopped around to lenders either; a member of our team reads your situation first and then calls. Use your latest real figures, not best-case estimates, so the lender we point you to is one that fits.
Frequently asked questions
What is the difference between profit and profitability?
Profit is the dollar amount left after costs, such as $90,000 for the year. Profitability puts that amount in context, usually as a percentage of revenue. A $90,000 profit on $300,000 of sales is far more profitable than the same profit on $3m.
What is a good profit margin for a small business?
It varies widely by industry. Retailers and wholesalers often work on thin net margins because they move volume, while professional services firms tend to keep more of each dollar. Comparing against your own industry, for example through the ATO's small business benchmarks, is more useful than any single number.
Do I need to be profitable to get a business loan?
Banks generally want to see profit, ideally across two years. Some non-bank lenders focus more on cash flow through your bank account, and property-secured lenders focus heavily on the security. A loss year with a clear explanation doesn't always rule you out.
Why does my accountant show low profit when the business feels busy?
Depreciation, write-offs, owner wages and private expenses run through the business can all lower reported profit. Lenders often add back non-cash and one-off items. Ask your accountant for a short summary of these so a lender reads the figures correctly.
How can I improve profitability quickly?
The fastest levers are usually pricing, cutting low-margin products or jobs, and reducing waste in cost of sales. Overheads matter too, but small price rises often have a bigger effect on margin than cost cutting.