The following tips will help you manage your profit margins more effectively.
Manage your gross margin
The simplest way to measure the profitability of a product or service is by its gross margin.
Gross Margin = (Sales Price – Material/Labour Costs)
For example, if you sell your product for $10 and it cost you $8 to make, you’ve made gross profit of $2. Therefore, your margin is 20 per cent.
This calculation does not include overheads like rent, equipment costs or selling expenses. The more costs you consider, particularly where they differ considerably from product to product or service to service, the more precise the picture of your true profit margin.
The moral of the story: Pay close attention to what influences your margins. Look to your competitors to find gross margin benchmarks or use industry averages as a guide.
Determine your pricing strategy
No matter what your business, the price you charge will have a direct effect on the success of your business. Whilst pricing strategies can be complicated, the fundamentals are:
- Set pricing to cover costs and profits
- Be responsive. Review your pricing regularly to reflect:
– market demand
– competitor activity
– profit objectives
Use KPIs and financial indicators relevant to your business/sector
Key performance indicators (KPI) are a way of measuring and monitoring the success of key activities to gauge where your business is heading. You need to think about how a KPI is helping your business meet its targets, but don’t confuse them with goals. KPIs need to be built around the process for generating profitable sales.
Here’s the distinction:
KPI = A metric or unit of measurement used to gauge the level of performance,
e.g. cost per order.
Goal = Target or objective intrinsic to your business strategy, e.g. increase sales to $1m per annum.
Here are 5 easy steps for setting KPIs in your business:
- Ascertain your business goals. Your KPIs must be linked to your goals.
- Use a flow chart. Map specific operations of your business and identify any processes that need refinement. Ask yourself what steps need to be taken to ensure the business achieves its goals.
- Set the KPI for each process. For example, deliveries should arrive within 1 hour of dispatch.
- Tell everyone involved about the KPI. Staff involved in that process must know what is being measured, how it is calculated and more importantly, what they must do to achieve the KPI.
- Regularly review. Always monitor your KPIs to make sure they are successful.
Remember: If you can’t measure it, you can’t manage it!
Want more articles like this? Check out the financial management section.
Understand fixed and variable costs
All businesses have costs; however, to increase your profits and drive your continued success you need to know what types of costs affect your business and how to successfully control them.
Fixed costs stay the same over the year. They are not directly related to the level of output or production, for example rent, depreciation, administration/office salaries, office utilities and office supplies.
Variable costs change as output changes; for example, raw materials, sales commissions, salaries to production workers and utilities used in manufacturing.
It is important to remember that costs can change from fixed to variable. For example, sales salaries – which are usually a fixed cost – can become a variable if your sales team work on commission instead of a base salary.
Know your break-even point
Your break-even point is the point at which total revenue equals total costs or expenses.
At this point there is no profit or loss – in other words, you ‘break even’.
Money from products sold above the break-even point adds to your profit. While the break-even point provides focus for your business, it also confirms whether the forecast sales will be enough to produce a profit and whether further investment in the product is worthwhile.
Managing your profit margins will make you more aware of the state of your business finances, enabling you to make decisions that will help increase profitability.
How important is managing profit margins to your business growth strategy?