The two basic ways of increasing your profits are increasing revenue and reducing costs. Many businesses make the mistake of focusing just on increasing sales. But, they somehow forget to apply cost-cutting measures which eventually end up reducing their profits. Gross profit margin is the percentage of revenue you keep after accounting for the cost of goods you sold.
Knowing your profit margin will help you interpret the profit potential of your business accurately. Here are reasons why you need to know your business’s profit margin.
Profit As A Measure Can Be Deceiving
Many businesses rely on the formula of subtracting total costs from total revenue to determine their profit. But, measuring the success of your business by considering profit alone can deceive you.
For example, if two companies spend $800,000 and $300,000 respectively to make a profit of $100,000 each, the two are not equally profitable. This is because the more a business spends to make a profit, the more it’s predisposed to minor cost shifts that can quickly add up and lead to substantial losses.
From the above example, if the first company spends $20,000 in health insurance and the second company spends $10,000 in health insurance, the profit margin will reduce differently for both companies in the event that insurance costs increase by 10%.
The first company’s profits will take a bigger hit reducing by $20,000 while those of the second company will reduce by $10,000. This means that the second company will be less affected or more profitable than the first company.
Profit Margins Will Give You A More Realistic Perspective
In order to get a clear picture of how profitable your business is, you need more than just the profit numbers. While profits are simply calculated as the amount of dollars, profit margins are the percentage of your income divided by revenue.
Continuing the two business examples above, the first company made total sales of $900,000, while the second company made sales of $500,000. So, their profit margins will be 100,000/900,000 or 11% and $100,000/400,000 or 25% respectively.
This means that while the two companies make the same amount of profit within a certain specific period, the second company is more than twice as profitable as the first company.
Creates Opportunities To Increase Profit Margin
By measuring your business’s profit margin accurately, you get a bigger picture of how profitable your business is. It also helps you to know how vulnerable your business is to sudden changes in fixed costs.
Therefore, by tracking your profit margin regularly you’ll be in a better position to implement effective strategies. These can help you keep the margins as high as possible.
You can achieve a healthy net profit by increasing the price of your goods after conducting a careful market analysis or by finding effective ways of controlling costs without compromising the quality of service.
Calculating your profit margin regularly will help you track the profitability of your business. It’s typically a percentage of your gross profit divided by revenue within a period of time.
Therefore, knowing your profit margin will help you evaluate the health of your business. It will also guide you in coming up with effective ways to make the necessary improvements.