Do You Understand Your Profit Margins?
Do You Understand Your Profit Margins? When was the last time you really examined your margins? This area of the 5 Ways is the easiest and quickest to improve if you scrutinise it and take action.
First, let’s clarify some key terms that are often confused. Margin is NOT the same thing as markup. Markup is a “worn-out” approach to pricing which gives you a false picture. The reason for this is that markup is based on cost and margin is based on sales. The main reason we should use markup in our discussions and comparisons is that the important aspects of the business use it.
For example, your financial statements (according to generally accepted accounting principles) are expressed using margins. Your tax returns are expressed using margins. If you have “markup” in your head and “margins” on the vital documents of your business, it’s no wonder you are confused when, after, the fact, you try to “reconcile” the realities you’ve experienced with the reports you see.
The two most common margins to look at are Gross and Net. Gross Margin is the result of subtracting cost of goods sold (COGS) from sales. This is expressed in dollars and percentage. For example, if you have sales of $50,000 and COGS of $30,000, this results in a Gross Margin of $20,000 and 40% (GP dollars divided by sales).
It is from the Gross Margin that all remaining operating costs are paid (rent, salaries, insurance, taxes, etc). What’s left over after all expenses are paid is Net Margin, which is also expressed in dollars and percentage. It is important to look at both margins and the “spread” between them as changes in pricing, business practices, repairs, etc. will impact one or both. It is also a great idea to periodically review individual jobs and campaigns for their respective gross and net margins. Doing so will help you pinpoint changes that need to be made. You don’t always want to wait until the end of the month to see how well you did; periodic review prevents unpleasant surprises.
Once you know your margins, you can begin to look at ways to improve them. On the “gross” side, look at deals that are available on frequently sold items. Sometimes, taking advantage of a special purchase or buying in a different bracket will boost gross margin instantly by lowering your product costs. Explore different suppliers, too. Maintain great relationships with your current ones, but always have a “back-up”.
When was the last time you raised prices? A price increase may be necessary and instantly improves margin. Here’s another benefit which is not often noticed: if product costs are increasing and you maintain the same gross margin, you increase the amount of “dollars” generated (and deposited into your bank account). In this regard, a little inflation is a good thing!
With regard to net margin, improvements in operating expenses drop right to the bottom line, increasing the net. Examine phone bills (and associated plans), office supplies (often a huge opportunity), fuel costs (routing and trip scheduling), insurance coverages (talk to you agent about limits and exposures), and marketing. Remember to test and measure your marketing; track it weekly, total it monthly, and evaluate it quarterly (before you make your next 90-day plan).
When considering marketing investment, a “mature” business can be in the 2% range, a new business might be near 10%, and most can fall into a 3-5% (of sales) range. If you stop spending money on things that aren’t working, the savings increase your net margin. Knowing, measuring, tracking and evaluating your margins are vital to success and growth. Make sure you are “on top” of yours.