What the heck is a business profit margin? Why is a profit margin important to you? How do you calculate it? How do you determine what the best pricing is to optimize for both the clients and the health of your business? What mistakes do most business owners make? I will answer all these questions and more in this article.
Many business owners don’t know the answer to the question “what is a good profit margin?” because they have not calculated it. I have found that many of my clients can actually do less and make more profit by calculating and adjusting their product or services profit margin percentages. It’s vital to the health of your business to monitor and adjust this on an ongoing basis, and it’s actually easy to do once you know how and practice a bit.
What is a good profit margin?
A good profit margin is a percentage of profit that allows you to pay all your fixed and variable expenses within your business and allow enough for expansion and growth while the client is still happy about the value of what they are buying vs. the money out of their pocket. A bad profit margin is a loss for the company or it is too high and too many sales are lost and gross profits go down. In order to determine your fixed and variable expenses for products or services, see our article here: http://peakbusinesscoaching.com/how-to-keep-track-of-business-finances/
How to calculate business profit margin?
Note* for our purposes, COGS = Cost of Goods Sold or cost of services
Business profit = retail price – COGS
Profit ÷ gross revenue = profit margin (as a decimal)
Profit margin x 100 = profit margin percentage
For example, if you have a retail price of $200 and your COGS is $80, your business profit is $120. Divide your profit of $120 by $200 and you get 0.60. Multiply 0.60 by 100% and get 60% profit margin percentage. You can do this by individual product or service hour or by volume numbers. For example, if you sell 5oo units at $200, your gross retail income would be $1000. You would then multiply your individual costs by 500 and do the calculations the same. This way you can see your total numbers while calculating your percentages. This only works if you sell one product or service. If you sell many, you’ll want to calculate your profit margin percents separately.
Many companies have a standard markup, or they base prices on demand and market conditions or even a whim. This can result in some products (from now on I’ll just refer to products, know that this all works for services as well) being sold at a loss and most products having a range of profitability. For example, a auto repair company might do oil change specials at a loss to bring in new clients. They would have to know how much they are losing and how much they gain in upsells after a complimentary inspection to predict and track the health or profitability of their business. In this same business, it’s interesting that high price items like engines or transmissions the profit margin is generally low while faster, more inexpensive repairs like brakes have a higher profit margin. This would counter our first impression that it would definitely be better to sell more engine or transmission repairs because of the gross income, while in fact it would decrease the health of the business. When you calculate profit margin percentages that are too low, you can discontinue the offer or increase your price. When you determine the highest margin products or services, you can focus your marketing and sales on these.
How do you determine what the best pricing is to optimize for both the clients and the health of your business?
The main idea here is to have a reasonable or competitive price and have plenty of profits to have a healthy growing business. My advice is to never compete on price. There’s always someone doing higher volume or buying bigger lots that can undercut your price. Always use amazing customer service and great products and emphasize these positive factors rather than price.
Covering your fixed costs can get complicated, so I advise using industry standards or research with other highly successful companies to get a starting place. The reason fixed costs are hard to calculate in is that fixed costs get diluted as your volume increases. Just know what your fixed monthly costs are and keep them in mind while determining your optimal pricing. The beauty is that once your fixed costs are covered, as you increase your profit margin or volume, your total profits go up much more.
Price profit margin percentages [PPMP’s] are different for each industry. You can do price comparisons or ideally contact successful peers, a consultant or industry specific association or manual to find your optimal PPMP’s. It may also depend on the local, seasonal or global economy. Your PPMP’s may change seasonally by demand, or you may even choose a break even point to keep your employees busy during slow times. You can also consider the loss leader approach to bring in new clients (Baskin Robbins pink spoon) and then upsell them other products or services.
General rules of thumb are useful as well. For retail, I don’t know anyone that does less than a 2x markup for products. Restaurants generally use 1/3 profit, 1/3 labor costs and 1/3 food costs. For services, I recommend 2-3x price to labor costs as a start, so you can reward them and give raises and still make a decent profit.
If you don’t think you have time or the math ability to do this, think again. For your own sake, please do this. If you want help or have any questions don’t hesitate to ask or contact Coach Jim. I’m happy to help and math is super easy for me. This one thing can increase profits by 50% while keeping your workload the same or lower! This is a huge gift, please receive it by doing it for yourself.
Another key point is that this should be done regularly! Sometimes your costs go up, and market factors vary all the time.
I’d love to hear any questions, successful case studies or comments below. Wishing you tremendous business success!