What is a Profit Margin and why is it important?

As a business owner I’m sure your focus is on making money or profit.  After all it’s the reward you get for taking risks and making investments.  You company will need profit to be able to grow and develop.  Having a profitable business also enables you to attract investors and funds should you need them.

This blog is going to look at Profit Margins in more detail and help you to see the importance of making sure that you really do know your business’s numbers.

What is a Profit Margin?

In order to be able to calculate your company’s profit margin you need to know the following:-

  • Sales – It’s not enough to know your total sales, you need to have the figures for each product or service that you sell. Why? The information will enable you to work out which products or services are the most profitable.
  • Cost of Sales – How much does it cost you to produce the products or services that you sell. For example raw materials and direct labour.  Again it’s important to know this for each item you sell. Why?  Without this information you will not be able to calculate which products or services make profit for your business.
  • Overheads – These are all the costs incurred as you run the business, so for example, heating, lighting, insurances, maintenance, staffing (those not involved in the direct making of the product/service mentioned in Cost of Sales), marketing.

Once you know these numbers you can use them to work our your Gross and Net Profit margins.  The margins will help you to see which areas of your business are most profitable and those that aren’t.  You can then  plan ahead, forecast your sales and also work out whether there are products or services that you should consider dropping from your offering.

Company – Knowing Your Numbers is Vital

Your company profit and loss account will reflect all your company income and costs and the overall company profit.  To find out which products/services and customers are contributing the most to your profit line you need to know your margins.

Without your margin information you might as well stick your finger in the air and take a chance  Not an effective way to run a business I would suggest.

What are the numbers for your business’s Products/Services

With the information you have you can now look at the products and services you provide and work out which ones are the most profitable for you.  This is where your focus should be, after all most businesses want to sell more of the things that make them the most money.

It is also worth looking at the items that make you the least profit and decide whether or not to discontinue them.   For some businesses it might be that a loss leader actually helps to generate sales of other items.

Customers? 

Having looked at the profitability of your products and services your attention should then shift to focus on your customers.  Understanding the profit  each customer brings is vital for you to make decisions about continuing to work with them.  

Effect of not knowing your margins

It’s important to know your margins as it’s the only way of knowing whether or not your business is profitable.   A business with a positive Gross Profit Margin but a negative Net Profit Margin is losing money.  However, you’ll only find out why if you drill down into the numbers.

Not knowing your margins will prevent you from being able to grow your business and potentially accessing finance.  You’ll also not know which areas of your business or which clients are making/costing you money.

Cash is King, without it you won’t stay afloat for long, however, if you are not making a profit the cash will soon run out.

Need help working out your profit margins?  Then give me a call on 07952 112432, or click here to send me an email to arrange a Free 121 coaching session.