Understanding and maximizing profit margins is critical to running a successful business. When business people say, “Profits lie in the margin,” they mean that by improving margins, companies can increase profitability and financial performance. Here’s a brief overview of the profit margins business owners should track to enhance performance and improve profits.
What is a Profit Margin?
The “margin” is the difference between the price a business sells its products or services for and the cost of producing them. There are three ways to measure a company’s margin:
- Gross margin (Revenue – COGS / Revenue) x 100%
Gross margin is the revenue from sales less the cost of goods sold, divided by revenue. Like all margins, it is expressed as a percentage. The cost of goods sold covers the direct costs of producing a company’s products and services, such as labor and materials. It does not include other expenses indirectly related to production, such as sales and marketing.
- Operating margin (Operating Income / Revenue) x 100%
The operating profit is calculated by subtracting operating expenses from gross profit. It is called the operating margin because it provides a window into the company's operations and efficiency.
- Net margin (Net Income / Revenue) x 100%
The net margin is derived from the revenue left over after deducting the cost of goods sold, operating expenses, interest, taxes, depreciation, and amortization. It is often referred to as the “bottom line” as there are no more indirect or direct expenses to deduct to calculate profitability.
Why Not Increase Prices?
Each type of margin measures profitability differently. Monitoring all three provides actionable insight for business owners to improve their performance. There are many ways to improve gross, operating, and net margins.
For example, if customer demand is sufficient, increasing prices can boost revenue and all three margins. However, higher prices might lead customers to buy less or find substitutes, reducing sales. Over time, even loyal customers may seek alternatives if prices become too high. So, how do businesses improve their margins without just raising their prices?
Boost Profit Margins with Better Cash Management
In practical terms, boosting profit margins typically involves a combination of tactics, which includes focusing on cash management.
Effective cash management provides many direct and indirect benefits. With sufficient cash on hand, businesses can pay for expenses without borrowing additional funds. Excess cash also makes it easier to purchase in bulk, receive discounts, and pay suppliers on time.
Sufficient cash on hand means business owners can make strategic purchasing decisions, such as launching a marketing campaign or buying the latest technology to improve the customer experience.
If nothing else, cash reserves allow business owners to respond to unexpected challenges and developments. For example, without cash to fund upfront costs, it would be challenging to fund a large, unexpected customer order.
Why Real-Time Expense Tracking Matters
Improving expense management is another way to enhance margins. Real-time tracking helps business owners monitor trends, identify and eliminate unnecessary spending, and stick to budgets.
The insight from real-time spending data allows managers to make informed decisions and address emerging issues before they have a significant impact. Better methods of tracking spending can also create a compelling case to renegotiate vendor payment terms and discounts.
Focusing on expense management makes it easier to detect excessive or unauthorized spending. Business owners can also anticipate the timing of expenses and avoid overdraft fees and late payment penalties. Real-time expense tracking can ensure businesses track and report all eligible deductions. This helps businesses avoid penalties and interest for late submissions or unnecessary amendments.
Boost Profits with Better Cash Management and Expense Tracking
In today’s fast-paced and dynamic environment, business owners must use every available tool to enhance profitability. Effective cash management and real-time expense tracking are critical for improving gross, operating, and net margins. Adopting these strategies can improve profit margins and deliver actionable intelligence that business owners can use to continually refine and improve their operations.
