Marcus Lemonis loves to remind business owners that “If you don’t know your numbers, you don’t know your business.” And those numbers he refers to include “margin” as in the profit margin, expressed as a percentage, on every product and service you sell. To make things a little more fun, for our conversation “margin” can be expressed after production costs (gross margin) and after operating costs (net margin). It’s important to recognize the difference to ensure we are looking at the right numbers to make decisions.
Profit Margin: Gross Margin
Gross Profit Margin is calculated by subtracting what it costs to produce something from how much it is sold for. For example, it costs you $5.00 to produce a widget (labor and all materials) and you sell it for $10.00. You have a 50% gross profit margin. This is only half the story though because you have other business costs (operating costs) that also have to be paid from the gross profit.
To figure out our net profit we need to further subtract the operating costs from the item. If each $10.00 item actually incurs $1.00 of operating costs, the net profit isn’t $5.00, it’s $4.00. That’s the number we want to work with for managing pricing and expenses. In our example, this $10.00 item has a 40% net profit margin.
Anything that affects that $4.00 net dollar amount affects the margin of the item. If costs go up or down, that $4.00 can get bigger or smaller. Let’s say that materials go up in cost $.50, so that costs are now, $5.50 to produce, the net margin goes down from $4.00 to $3.50. From 40% to 35%. Make sense?
If you don’t know your margins, you need to take a little time to figure them out. The amount of margin that’s considered “good” or “healthy” varies by industry. Restaurants typically have lower margins than retail and retail is typically lower than many service provider businesses. Online businesses have lower operating expenses and often higher margins than businesses with physical locations.
PROFIT MARGIN: WHAT AFFECTS IT?
This article is about the things that affect your margins, and margins can be the difference between struggling and thriving. And those things are many. Changes in any costs can affect your margins and require you to address your pricing to maintain your profits. Any cost. Utilities, service providers, suppliers, and other expenses can go up in cost at any time unless you are under a contract.
As margins go down, there is less and less money left over, and it can affect your growth and your ability to weather any unexpected events. This is why I encourage entrepreneurs to check their expenses through the Breakthrough Number process once a quarter. You can use these resources to figure yours. Keeping your eyes on the margin can help you head off issues that can affect the health of your business. Set aside the time to learn your numbers.
If you want to walk through a step-by-step method to manage your margins, your income, and profitability, join me for the next Quarterly Intensive. Visit https://entremoneycoach.kartra.com/page/quarterlyintensive to learn more.