What Is a Good Profit Margin for a Service Business? IRS Figures by Trade

IRS figures by trade: offices, agencies and practices

Same report, same three figures. In professional practices, officers’ pay changes the reading: in legal services it was larger than net income, and in physicians’ offices it was more than twice as large.

• Legal services: 15.4 percent net income; officers’ pay 16.2 percent; 72 percent of returns showed net income.
• Accounting, tax preparation, bookkeeping and payroll services: 12.0 percent; officers’ pay 5.4 percent; 78 percent.
• Architectural, engineering and related services: 7.9 percent; officers’ pay 4.5 percent; 68 percent.
• Computer systems design and related services, the group for IT services firms: 5.0 percent; officers’ pay 3.0 percent; 56 percent.
• Employment services, which holds staffing and temporary help firms together with placement agencies, executive search and professional employer organizations: 4.5 percent; officers’ pay 1.3 percent; 67 percent.
• Insurance agencies and brokerages: 12.1 percent; officers’ pay 5.0 percent; 75 percent.
• Other real estate activities, the group that holds residential and nonresidential property managers along with appraisers and other real estate services: 7.5 percent; officers’ pay 5.7 percent; 45 percent.
• Offices of physicians: 4.7 percent; officers’ pay 10.2 percent; 66 percent.
• Offices of dentists: 11.1 percent; officers’ pay 12.7 percent; 74 percent.
• Miscellaneous health care and social assistance, the group that holds home health care and services for the elderly along with medical labs, ambulance services and child care: 4.6 percent; officers’ pay 3.2 percent; 65 percent.
• Personal and laundry services, which counts beauty salons, barber shops and nail salons with dry cleaners, funeral homes, pet care and parking lots: 7.7 percent; officers’ pay 5.7 percent; 67 percent.
• Health and personal care retailers, the group for pharmacies and drug retailers of every size, along with cosmetics and optical retailers: 3.8 percent; officers’ pay 0.5 percent; 60 percent.

A few limits apply to every figure on both lists. They cover corporations only: partnerships, LLCs taxed as partnerships and sole proprietors file other returns and are not in them. They are estimates from a sample of returns, so a few tenths of a point between two groups mean nothing. They follow tax rules, which can differ from the company’s own books for the same year; depreciation on trucks and equipment is one example. And 2022 is one year, with its own prices, wages and interest rates, not a trend.

Why a trade-wide figure cannot set one company’s margin

Each percentage is all the net income in a group divided by all the receipts in it. A corporation with $500 million in receipts counts a hundred times as much as one with $5 million, so the figure leans toward the largest companies in the group, whose costs, prices and customers may look nothing like an owner-led company’s.

It also blends winners and losers. Table 5.2 of the same report covers only the returns that showed net income. In the plumbing, heating and air-conditioning group, 70 percent of corporations reported net income, and those earned 6.8 percent of their receipts, against 4.8 percent for the group as a whole. In other real estate activities, the group that holds property managers, only 45 percent reported net income, and those earned 27.6 percent. In computer systems design, 56 percent reported net income, at 14.2 percent, against 5.0 percent for all. A trade average can sit between two very different sets of companies and describe neither.

Then the mixed groups. Janitorial and landscaping companies share a line with security guards and call centers; home care agencies share one with medical labs and child care. A figure for the group says little about one kind of business inside it.

None of this makes the figures useless. They answer one honest question: is the company’s margin in the same neighborhood as its trade’s, or far from it? A company well below its trade has a question to answer. A company above it still has one: whether its margin holds up job type by job type, or only on average.

Gross margin, net margin or owner’s pay: which number are you comparing?

Three different numbers go by the name profit margin, and setting one company’s gross margin beside a trade’s net margin answers nothing. Name the number first.

• Gross margin: receipts minus the direct cost of the work — field labor at its loaded cost, materials, subcontractors, equipment and disposal — divided by receipts. It shows whether the work itself is priced right, before office rent, office staff and the owner’s salary. The IRS tables do not give a clean trade gross margin: by the report’s own definitions, direct labor can sit inside cost of goods sold, and salaries and wages exclude “amounts included in the cost of goods sold,” so that line depends on where each company books its field payroll.
• Net margin: what is left after every expense, overhead included, divided by receipts. The IRS figures above are this number, before income tax.
• Owner’s pay: what the owner takes for working in the business. Depending on how the company is set up and how the owner is paid, it sits above the net line as a salary or inside it as profit.

Owner’s pay is where comparisons go wrong. In the IRS tables, officers’ compensation is deducted before net income, so an owner who draws a full salary shows a thinner margin than one who draws a small salary and takes the rest as profit, with the same business underneath. The IRS says S corporations “must pay reasonable compensation to a shareholder-employee in return for services”; what that amount is belongs with the company’s CPA. For comparison, the fix is arithmetic: add the owner’s salary back to the company’s own net income, and set the total beside the trade’s net income plus officers’ pay. For plumbing and HVAC that combined figure is 8.1 percent of receipts; for legal services, 31.6 percent; for dentists, 23.8 percent. If the owner draws no salary at all, put a market wage for the work the owner does — selling, estimating, scheduling, managing — into expenses before reading the margin. Officers’ pay can include officers who are not owners, so treat the combined figure as a rough line, not an exact one.

How to work out the company’s own margin by job type and by customer

The company’s own margin starts with the last twelve months of invoices, not with the tax return: one row per invoice, with the job type and the customer on it, and beside each the direct cost of that job. The bookkeeper pulls the invoice register and the payroll or timecard export; whoever dispatches or schedules tags each job with its type; the owner reads the result. Each row needs:

• Revenue per invoice, extras and change orders included, and any credits or write-offs taken against it.
• Field hours on the job, from the timecard or the ticket, times the loaded cost of an hour: the wage plus payroll taxes, workers’ compensation and benefits, at the company’s own rates.
• Materials and parts, from supplier invoices or the job’s purchase orders.
• Subcontractors, equipment rental, disposal and permits charged to the job.
• Return trips on the same job, with their hours and parts, added to the original job rather than booked as a new one.
• Gross profit per job, in dollars and as a share of its revenue.

Then add the rows up two ways: by job type and by customer. Overhead stays out of this step; it is subtracted once, as a total, to get from gross profit to net. Illustrative example: a hypothetical HVAC company bills $3 million a year: $1.2 million of service calls, $1.5 million of replacements and $300,000 of maintenance visits. Gross profit comes to 45 percent on service calls, 30 percent on replacements and 10 percent on maintenance visits, $1.02 million in all. Overhead, with a market wage for the owner’s work in it, is $870,000, leaving $150,000, or 5.0 percent. The company sits close to its trade’s line, and the line says nothing about maintenance visits that earn 10 cents on the dollar before a single overhead cost. Sorted by customer, the same rows show which accounts bring gross profit dollars and which ones only bring volume.

What separates one company’s margin from its trade’s figure

When a company sits below its trade, the gap is a list of specific dollars, and the company’s own records hold them. Four places to look first:

• Unbilled work. Extras done on site and never invoiced, change orders agreed and left off the bill, time and materials that stayed in a technician’s notes. The labor and parts are already paid for, so every dollar of it that gets billed goes straight to net income.
• Callbacks and rework. A callback is a return trip nobody bills: hours, parts and a truck spent on a job already closed. Count them each month with their cost, by job type and by technician or crew.
• Slow collections. Money that arrives late does not lower the margin until it turns into interest on a line of credit or a bad debt; both are deductions above the net income line. Track the days from job finished to invoice sent, and the company’s days sales outstanding.
• Prices that have not moved. A price list or a service agreement still at an old number while wages and parts went up. The gross margin by job type shows it first.

Illustrative example: the hypothetical HVAC company above finds $36,000 of extras done during the year and never invoiced, and 120 callbacks at about $150 each in labor and parts, $18,000 in all. Billing the extras would have added $36,000 to net income, since the costs were already on the books; avoiding half the callbacks would have kept another $9,000. Together that is $45,000: net income of $195,000 on $3.036 million of receipts, 6.4 percent instead of 5.0, without a single new customer.

What to check every week, and where the Review fits

The margin itself is a monthly number: it needs the month’s payroll, supplier bills and invoices closed. The things that move it can be read every week, from records the company already keeps, each by one named person.

• Jobs closed this week, with gross profit per job and the three lowest named — the office manager.
• Extras and change orders done this week, against those invoiced — the person who writes the invoices.
• Callbacks this week, with their hours and parts — the service manager or crew lead.
• Jobs finished and not yet invoiced, and invoices past their terms — the bookkeeper.
• Once a month: gross margin by job type and by customer, and net margin with the owner’s pay counted, each set beside the same month last year — the owner.

If those numbers are already on one page and someone reads them, the IRS figure has done its job: it shows the neighborhood. If the company sits well below its trade and nobody can say which job types or customers put it there, the Revenue Review is the paid next step: two weeks, read-only access to the company’s own invoices, job records and payroll, and a written report the company keeps that prices each gap — unbilled work, callbacks, slow collections — as a monthly dollar figure where the records support one. It gives no tax or accounting advice and does not replace the CPA. It is not worth buying when the arithmetic above can be done in-house in an afternoon. The free 20-minute call is where we say which of the two applies.