What is profit margin? How do you calculate it? And why is it important?

0

Running an e-commerce business is not without its challenges, one of which is making enough money to keep your doors open. Did you know that in the e-commerce sector, only 20% of companies survive? This indicates that 80 out of 100 businesses are either losing money or breaking even on their expenses. That’s why tracking your profit margin is key to assessing your situation and taking action to keep your business afloat.

What is the profit margin?

Profit margin is the percentage of sales revenue that a business retains after all expenses have been paid. Put simply, it calculates the amount of revenue you receive from a sale that you keep. The financial health of your business improves as your profit margin increases.

There are different types of profit margins, with the following three being the most popular:

  • Net margin (net profit margin)
  • Gross margin (gross profit margin)
  • Operating margin (operating profit margin)

Here is a detailed explanation of each category.

Net profit margin is the profit of the organization after deducting all its costs, including operating expenses, product price, and interest and tax payments.

Formula for calculating net profit: – (total revenue – total costs) / total revenue (x 100).

You can gauge the overall success of your business by calculating your net margin. A high net margin shows that your business manages its costs very well and generates sales.

Additionally, you can use the net profit margin to gauge how well your business is performing against its competitors. However, the companies must have roughly the same cost structure and consumer base for the comparison to make sense.

Gross profit margin is the company’s profit after deducting the costs associated with making and selling its service or product.

Cost of goods sold (COGS) must be subtracted from total revenue in order to calculate gross profit. To calculate the gross profit percentage, divide the sum by the total revenue and multiply it by 100.

Formula to calculate Gross Margin: (Total Revenue – COGS) / Total Revenue (x 100).

It’s best to remember that COGS only refers to direct property costs and not indirect expenses such as rent or office supplies.

You can also calculate gross profit to determine if your business is profitable and if you need to change prices. If your gross margin is low, it may mean that you need to charge more for an item to make it profitable to sell.

What is the optimal gross profit margin?

You need to set fair prices for your products or services to increase your gross profit. Different industries have different optimal gross margin figures. That’s 45.25% of online sales, according to the NYU Stern School of Business.

Shopify’s Profit Calculator can help you determine the most profitable selling price for your products and services. This tool calculates the cost of your merchandise to consumers so you can achieve the highest profit margin.

Operating profit margin

Operating profit margin demonstrates the profit of an organization after taking into account the variable costs (i.e. indirect costs) associated with running your business.

Compared to gross margin, operating margin takes into account a variety of other operating costs such as rent, labor costs, utilities, advertising, payroll, insurance, etc

Additionally, you can better understand your pre-tax profit and how operating expenses affect your company’s profitability by calculating operating margin.

Subtract operating expenses from total revenue to calculate operating profit. After that, divide the sum by the total income and multiply it by 100.

Operating Profit Calculation Formula: – (Total Revenue – COGS + Operating Costs) / Total Revenue (x 100)

What is a favorable profit margin for your business?

Your business’ profit margin will vary depending on your location, customer base, and industry. In general, a net profit margin of 10% is considered a good margin, a profit margin of 20% is considered excellent, and a profit margin of 5% is considered poor. If you want to compare your business performance based on net margin and gross margin, you need to check the average profit margin for your industry.

How to increase profit margin

1. Reduce operating expenses

Reducing expenses and operating costs is a quick and effective strategy to increase profit margin.

Even though these costs differ from business to business, you should check out common expenses incurred in running a business, such as:

  • Labor costs
  • Licenses
  • Insurance
  • Office space and utilities
  • Cost of maintenance and equipment
  • Social advantages

Then think about how you can reduce operating costs and how technology can be used to your advantage. For example, if you offer 24/7 customer service through Facebook and have 3 employees working an eight-hour shift, you can reduce your operating costs by using a chatbot during off hours.

2. Increase your average order value

The average dollar amount a consumer spends on each purchase from your store is called AOV (Average Order Value). A simple strategy to increase your profit margin rate is to increase the AOV.

There are several strategies to increase your average order value, including:

  • Create product packages or bundles: – Product bundles work great to increase the perceived value of a consumer’s purchase and help improve the shopping experience. Make product bundles more affordable as a group than as a single item to encourage individuals to make larger purchases.
  • Complementary cross-sell and up-sell products: – You can suggest products that match well with the items a visitor has in their cart rather than just recommending your store’s bestsellers. For example, shaving cream with razors or a mixing bowl for hair dye.
  • Provide Incentives for Minimum Orders:- You can increase your AOV and achieve higher margins by encouraging consumers to spend a minimal amount. Offering free shipping with a minimum purchase is one method of doing this, which you can usually set up in Shopify in minutes.

3. Be prepared to take a loss on some orders

It’s okay for your e-commerce business to lose money on some orders if it helps you get to know your consumers better. Consumers today are so used to receiving poor service that they aren’t surprised when a company tries to build a lasting relationship.

How to invest in the future of your customer relationships? Here are some concepts:

  • A consumer is not satisfied with his order? Please give them a partial refund to make up for the disappointing experience.
  • If something cheap item breaks, immediately send the buyer a free replacement without the hassle of returning.
  • If a customer wants to return a large item, send them a replacement item immediately after they provide the return tracking information rather than waiting for the item to arrive at your warehouse.

These tactics will initially cost a bit more. Nonetheless, they will have a significant impact on you as you develop a passionate and dedicated following that will improve the financial health of your business.

4. Raise the prices of your products

Many business owners worry that their customers will leave them if they increase their rates. However, if you provide customers with a wonderful experience and proactively resolve their issues, a small price increase can do wonders for your business.

Additionally, it would be best to consider psychological and creative strategies when pursuing this method. For example, if you sell a product wholesale and retail, you can keep the retail price as is while increasing the wholesale price by $5. In this way, consumers would always receive a good price when buying in bulk, while your business would enjoy a higher profit margin.

5. Establish a consumer loyalty program

Consumer loyalty programs are proven methods for increasing profitability in the service and retail industries. For example, Sephora has a customer loyalty program with over 17 million members, contributing about 80% of the company’s sales.

Instead of investing money in new campaigns, you can quickly increase your profit margins by creating a customer loyalty program.

Additionally, you can set up a loyalty program where consumers receive point-based rewards for every purchase. Once they’ve accumulated enough points, allow them to choose how to use their points, whether through gift cards or rebates, to help with the purchase price.

Conclusion

Profit margin is an essential metric for businesses to track. It gives an overview of the profits made by a company and can be used to compare the profitability of different companies. The profit margin is essential because it shows how much of each sales dollar is actually turned into profit.

Tracking your business’ profit margin can help you decide what steps to take to ensure its survival and growth. You need to maintain the consumer experience while doing this. By following these suggestions for increasing your profit margin, you can establish a solid foundation for your business and prepare it to withstand any future economic turbulence.

Share.

Comments are closed.