They say you can’t have your cake and eat it too. But we say cake is meant to be eaten. You see, starting a business is a lot like making a cake (stick with us, here). You need a recipe, supplies, and a lot of quality ingredients—and it’s going to cost you upfront. But, in time, you’ll have a delicious cake that you made from scratch. You deserve a piece.
When it comes to baking a cake—er, starting a business—things like startup, payroll, and manufacturing costs all impact your business’s profitability from the get go. And there’s no sugarcoating the fact that it can take years for a new business to see a profit. But understanding profit margins can help you reach profitability (ie: the cake eating part) faster.
If your business is already profitable, improving your profit margins can help you bring in more money. For this reason, your profit margins should always be top of mind—whether you’re new to business or a seasoned pro.
What is a profit margin?
So glad you asked. Your profit margin is the percentage of profit you keep from each sale, or how many cents of profit you make from each dollar of sale. For example, a 25% profit margin means you earn $0.25 of profit for each dollar of sales generated.
Time for a little math (just a little, we promise). To calculate your business’s overall profit margin, use the following formula:
Profit Margin = (Net Income / Revenue) X 100
Find your net income by subtracting operating expenses from revenue (also called net sales). Divide net income by net revenue and multiply the total by 100 to get your profit margin percentage.
Understanding your business’s profit margin
Calculating your profit margin is only the first step. Actually understanding it is a totally different story. Getting a grasp on your profit margin can help you determine whether or not your products are priced correctly, your inventory is moving, or your business is making money. For example, a low profit margin may indicate that your products are priced too low, your inventory is imbalanced, or you need to take another look at your promotions.
Unfortunately, the difference between a “good” and “bad” profit margin isn’t always clear. A low profit margin for one business might be considered high by another. That’s because profit margins vary by industry and even by product. For example, according to Vend’s 2019 Benchmarks Report, the average profit margin on alcohol is around 35%, but the profit margin on non-alcoholic beverages is closer to 66%.
In the US, the average profit margin in retail is around 53%. Yours may be higher or lower depending on your industry and the products you sell. To better understand your own profit margin goals, it’s a good idea to research similar businesses in your area, including your competitors. Knowing their profit margins will help you understand where your percentage should be.
3 ways to maximize your profit margiin
Your profit margin isn’t set in stone. Quite the opposite, actually! This is one metric you should always be working to improve. If your profit margin isn’t on the up and up, it’s a sign your business isn’t doing as well as it could be. Here are a few tips to help you maximize your margins
1. Increase your prices
If you haven’t raised your prices in a while, a low profit margin may indicate that the time has come. Raising your prices offers an opportunity to make more money on each sale—which, in turn, increases your profit margin.
But pricing can be a sensitive subject. Your pricing strategy is built on several factors including the economy, your competitors, and your target market. Before you make any decisions, run a competitive analysis. Find out how your competitors are pricing their products and services. You want to offer competitive pricing, but if your products are priced too low compared to the competition, you might actually be underselling your offerings. Increasing your prices can increase the perceived value of your brand.
Once you’ve determined that a price increase is the right move for your business, start small. Raising prices across the board can be jolting for your customers. Consider updating the prices of your top sellers first to maximize your profit margins right away and gauge customer reactions.
2. Manage your inventory
If you don’t have a good handle on your inventory, you might end up with a surplus of product that simply isn’t selling. When this happens, you might resort to markdowns to get that inventory out the door. Markdowns can significantly decrease your profit margins. But! A solid inventory management system can help you avoid over-ordering a product that will only end up on the discount rack.
Knowing exactly what you have on hand and how fast or slow it’s moving can help you make better decisions about purchasing and sales. But even the best inventory management systems can’t predict the future. Repeat after us: markdowns happen. If you must markdown:
Remember, to increase profitability, you should focus your best efforts on selling your most profitable products and services.
3. Lower your purchasing costs
Increase your profit margins (without raising your prices) by reducing purchasing costs from vendors and suppliers. In some cases, this can be as simple as asking a vendor (as nicely as possible) for a discount. In others, you may need to reassess your supply chain.
Start by having a discussion with your vendors and suppliers. If you’ve been a valuable customer, they might be willing to negotiate their prices or throw in some extra units at no extra cost. If you buy a product in bulk, you can usually work out a deal. In most cases, the bigger your order quantity, the less you pay per item. If you can’t afford to increase your order quantities on your own, consider partnering with another business that sells the same product.
If you’ve already maximized your vendor discounts, it might be time to check for inefficiencies in your supply chain. Ask your vendors and suppliers if there’s anything you can do to make the process easier or most cost-effective for you both. For example, shipping less product more frequently is more expensive than shipping more product less frequently. If you’re receiving weekly shipments on a half-empty truck, it might be more cost-effective to receive biweekly shipments on a full truck. It’s a win/win for you and your vendors (and the environment!).
Bring it back to your bottom line
Your profit margin is just one piece of the profitability pie (or, in this case, cake). Overhead, startup, and payroll costs can all impact your bottom line. But maximizing your profit margins, increasing productivity, and eliminating unnecessary expenses all have the power to make you more money. And who doesn’t love that?
Tracking expenses is easy when you use an accounting software like QuickBooks Online. QuickBooks automatically tracks and categorizes business expenses, providing you with the data you need to predict and manage your cash flow. If you use Amazon Business, the Amazon Business Purchases app is a smart and simple way to track and import transactions in QuickBooks. Built-in expense reports, like profit and loss statements, give you valuable profitability insight at a glance, so you can make informed financial decisions.
Just remember to revisit and optimize your profitability ratios regularly. Even a small change can make a big impact on your business.
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