Profit margin is an indicator that shows how much money an entrepreneur makes from the sale of each product, in addition to allowing an assessment of the company’s finances. The importance of knowing the company’s profit margin is to have an idea of the profitability and yield of the business, understand the possibilities of loans, investments and have an idea of the company’s health.
How to establish a profit margin?
A good profit margin depends on factors such as: industry, company size, competitors’ prices and target audience demand. By considering these elements, you can find the equilibrium price, which is ideal for the success of your product.
The ideal profit margin varies from company to company. For example: when the manufacturing of the product becomes more optimized and consequently cheaper, the profit margin ends up being higher. This can mean a high profit. On the other hand, in large retail companies, for example, which have a lower profit margin because they offer more affordable products, the number of sales ends up being boosted and so does profitability.
The service sector generally has a higher profit margin because, unlike the others, it does not have to bear as many production costs and depends on the capacity of human labor, with fixed costs being the main expenses. Even so, it is important to remember that the materials used to provide services must be taken into account, such as shampoo in the case of a beauty salon.
How to calculate profit margin?
Calculating the profit margin can be done using a very simple formula: Divide the company’s profit value by the total price of the product and then multiply the result by 100. In other words, if you sold the product for a thousand and made a profit of 150, for example, the profit margin would be:
150 ÷ 1000 = 0.15 X 100 = 15%
This calculation helps you understand which products are worth investing in, as well as those that require a larger number of sales to have a significant impact on your company’s revenue. This way, you can improve your sales strategies and make more informed decisions about your company’s catalog.
Difference Between Gross Profit Margin and Net Profit Margin
While the net profit margin considers the company’s fixed costs, such as salaries, taxes and other bills that must be paid regardless of how sales and cash inflows are going into the company, the gross profit margin considers costs that are related only to the product, that is: raw materials, production, logistics , etc. These are variable costs that change according to production and the amount of sales in each month.
Calculating the gross profit margin is important for the appropriate pricing of each product. The net profit margin is used to understand how much the entrepreneur is actually earning from each sale, without considering the company’s financial obligations.
An important factor in a company’s net margin is to observe fixed and variable costs, examples of which include taxes, which can vary depending on the market segment, production costs and other expenses such as energy, salaries, packaging and commissions. By keeping all these factors in mind, you can not only calculate the net margin but also observe its evolution over time.
Learned about profit margin?
It is important to plan carefully to maintain the company’s financial health and to consider variable expenses when defining a profit margin. This avoids potential complications and losses that can be avoided with a more in-depth understanding of expenses and profit margin.
Finally, it is important to emphasize that each company has a unique profile and therefore, financial scenarios vary from one to another. Consider what makes sense according to the characteristics of your company, as there is no magic or exact formula for how financial management should be done.