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Welcome to this week’s installment of Chalk Talk by ActionCOACH of West Texas! Chalk Talk is a quick business tip related to current market trends or what we are talking about with our clients. If there is a certain subject you would like us to cover please let us know!
Below you will find “Understanding Your Profit Margin”
As recent as 2015 people believed that the average company saw a 36% profit margin. Unfortunately, this number is far too high. In most instances, a business is doing well to see a profit margin close to 7.5%. Granted this number is across 212 industries, but it still shows the perception versus the reality of profits in business. Small businesses tend to see 7% profit margin, so it’s even lower than average! So why do we have such a gap in what we perceive versus what is real? We don’t understand our profit margins!! This isn’t to say that a 36% profit margin cannot be obtained, but it is to say that we will never reach that number if we don’t understand the following: where we are currently, why we are currently where we’re at, and first steps towards improvement.
All the best,
ActionCOACH of West Texas Team
WestTexas.ActionCOACH.com
RorySheppard@actioncoach.com or LeifKertis@actioncoach.com
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Understanding 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 scrutinize 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.
If the cost of an item is $0.50 and you have a markup of 100% ($0.50) taking retail price to $1.00, your margin is only 50%. The real negative impact of the markup mindset happens on the discount side: subtracting a 10% discount from 100% markup is a 20% hit on profit margins.
The main reason we should use margin 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, two levers are:
- price increases
- lowering cost of product / service for sale.
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”.
With regard to net margin, improvements in operating expenses drop right to the bottom line, increasing the net. Examine:
- phone & technology costs (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)
- 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).
If you stop spending money on things that aren’t working or are unneeded, 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.
Only Action gets you closer to your dreams – do something today that your future self will thank you for.”
– COACH RORY
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