How to manage margins

As a business owner, if it is costing you more money to create your product than you are making when you sell it—you have problems. But how do you calculate your ideal profit margin? And once you do so, what are some ways to maximize it easily?

First off, what is profit margin? It is the ratio of profits earned over total costs for a given amount of time, like a quarter or a year. A correctly calculated profit margin will show how a business allots its resources and will give good insight into the business’ profitability. You can calculate profit margin in two ways, either the gross profit margin or the net profit margin.

Gross Profit Margin: The gross profit margin determines the profitability of an item or service. You would take the retail price of the item and subtract the cost of the labor and supplies needed to create it. Then you would divide that amount by the retail price. For example, if you sold homemade candles at $20 each and it cost you $10 in supplies to make the candle, your profit margin on the candle would be 50% (20 – 10 = 10; 10/20 = .5, or 50%).

Net Profit Margin: This ratio determines the profitability of the company as a whole. To calculate it, take the total sales of the company and subtract all expenses, then divide by the total revenue. So if your company has total sales of $2.2 million and your expenses equal $1.5 million, your profit margin would be 32% (2.2M – 1.5M = 700K; 700K/2.2M = .318, or 32%).

Knowing what a profit margin is, here are five easy ways to build a better one for your business:

1. Cheaper alternatives. The profit margin depends not only on the amount of sales, but also on the cost of the goods needed to make the product. Therefore, if you can reduce the cost of the products, you will increase your profit margin. Take a look at different suppliers or consider working out an arrangement with them to lower the price of the goods you need. If you buy in bulk, they might be willing to drop the price for you. While you are considering cheaper alternatives, take a look at the business costs as a whole. Determine whether or not every expense benefits your business. If you find one that doesn’t, consider getting rid of it entirely.
2. Change the price. If you increase the cost of the item or service you sell, you will increase profit margins … as long as the rate of sales doesn’t decrease. This really depends on the industry that you are in and whether you have the flexibility to adjust your pricing. Be sure to do a little market research before changing the prices and get ready to change it back if sales drop.
3. Customer relations. Sometimes a little change in the way your business responds to customers can make a big difference in your bottom line. Consider investing in CRM software with marketing and sales force automation to better reach and respond to your customers. It will track all of your customer interactions and information in one place to drive sales and increase productivity.
4. Shake things up. Look at offering new products or improve the ones that you already sell. If you are a service-based business, consider expanding your range or putting together a package of services for a slightly increased price.
5. Set up an inventory system. By creating an inventory system and keeping it up to date, your increased efficiency will help you find the right amount of working capital to keep tied up in inventory. In addition, an inventory system enables you to keep track of which products sell well and which ones sit on your shelves forever.

   Of course, we encourage you to talk to your financial advisors before making any big changes. Have them help you make a plan to increase your profit margins and continue to tweak it until you have the results you are looking for.