Business owners need to understand their revenues and earnings to make effective business decisions. However, it’s not easy to keep track of this information manually because unanticipated expenses often come into play. The profit margin formula helps business owners quickly gauge their company’s financial health. Profits are the ultimate goal for every business, so every business owner should know how to use this metric. Here’s what you need to know about profit margins:
Profit Margins: Explained
Profit margins measure a business’s profitability by examining take-home earnings in proportion to overall revenues. Accountants usually write these figures as percentages that reflect the profits earned on every sale. There are several different types of profit margin formulas, but we’ll focus on net profit margins here.
Net-profit margin percentage shows you how much profit you bring in on every dollar in sales. For example, a 50% profit margin means you earn 50 cents worth of profit on every dollar in sales. Businesses with higher profit margins are more profitable than firms with slimmer margins.
Average profit margins vary based on a variety of factors, so there is no universally accepted ‘good’ or ‘bad’ profit margin. Generally, it’s desirable to keep margins as high as possible, but you need to consider business conditions in your industry to determine a healthy margin goal.
What is the Profit Margin Formula?
It takes a little bit of math to calculate your business’s margins. Most accounting software can tell you this automatically, but you should know also know how to calculate it manually. The formula is simple enough, it goes:
Net Profit Margin = (Total Net Income) divided by (Total Revenues) x 100
Example
Your business earned $100,000 in profit in the second quarter, and revenues came in at $300,000. To calculate the net margin, take the $100,000 quarterly profit and divide it by the $300,000 representing revenues. The final product is 0.33. Multiply the total by 100 to get a whole number percentage of 33%.
$100,000 (earnings) / $300,000 (revenues) = 0.33 X 100 = 33% Net Margin
Why are Profit Margins Important?
Profit margins are important because they give you an idea of what to expect in the future. When you understand how much money your business makes, you can make more accurate financial decisions. This crucial piece of knowledge is invaluable when making substantial investments in your business, and it can also help you develop more accurate budgets and forecasts.
Profit margins also provide a clear picture of your business’s overall health. You can repeat the same formula using a variety of different parameters to focus on different areas of your business. For example, calculate margins for each particular product or service to identify your most profitable margins. Or, look at the numbers on a month-by-month basis to determine your prime selling season. Each piece of information can provide valuable insights for business owners.
Tips for Improving Margins
Increasing your profit margin can help your business make more money without growing sales. Instead of focusing on growing revenues, you can improve your profits by making your business more efficient. Higher margins help you make more money from the sales you already have, so it seems like a much more attainable goal for many companies. Here are some ideas that can help you pump up your margins:
Monitor Spending
Strong expense tracking protocols help businesses stay accountable for their spending. You can also review your expense records to see where you’re going over budget.
Stick to Your Budget
Regularly develop and adjust budgets to give your business a guidepost for staying on track. If you’re consistently going over budget, back-track through your books and find out why.
Take Advantage of Discounts
Shop around for deals and take advantage of discounts whenever available. Contact your regular vendors and see if they’re willing to offer you more favorable terms for repeat business.
Minimize Costs
Identify ways to lower your operating costs so you can increase your profit margin.
Elevate Your Brand
Stand apart from your competition to break away from the rat race and start attracting more customers organically.
Streamline Operations
Eliminate waste and operation inefficiencies so you can reduce your overall costs.
Increase Rates
Raising rates is a significant decision for any business, but sometimes it’s the right one. If you’re not earning enough at your current price points, you might want to consider raising your rates.
Foster Positive Customer Relationships
It’s a well-known fact that signing a new customer costs significantly more than keeping an existing one. Hold onto your customers and give them good reasons to come back. Satisfied customers also tend to refer their friends, so building customer loyalty can lower your long-term customer acquisition costs too.
Promote your Business Efficiently
Many businesses spend a large portion of their budget on advertising, but promotion isn’t worth it if it’s not carrying its weight. Make sure your ad campaigns are performing well enough to justify the expenditure. If it’s not, you should put the money to use elsewhere.
More Answers to Your Bookkeeping Questions
Profit margin is a relatively simple accounting metric, but it’s just the beginning. Unfortunately, most business owners are too busy to learn accounting principles from scratch and simultaneously manage their business. That’s why many growing firms outsource their accounting to professional bookkeepers. Shared Economy Tax offers affordable bookkeeping services that are ideal for growing companies. Find out if our services are right for you by signing up for a one-on-one strategy session with one of our bookkeeping pros today. We’ll take care of your books so you can focus on business. You can also sign up for our complimentary newsletter using the form below for more accounting tips.