A profit margin increase sounds like good news to any entrepreneur, achieved by either an increase in revenue or a reduction in costs. Basically defined as the amount of profit left after deducting costs, the profit margin has become one of the easiest and most common indicators of how well a business is doing.
Of course, checking and ensuring a profit margin increase is not the endgame of any business. To help you better understand this ubiquitous metric, and better wield it for your business’ growth, here are five things you definitely should know about profit margin increase.
1. There’s not just one profit margin to understand
Profit margin, in general, is computed by deducting your business costs–those directly related to the production of your goods or the provision of your services like raw materials and labor–from your revenue. This specifically refers to the gross profit margin, one of the most important profitability ratios you have to know. Aside from this one, there are other kinds of profit margins that give you different dimensions of how well your business is doing compared to a certain level of costs associated with it.
After your gross profit margin, you can start deducting operating expenses like costs associated with all general and administrative expenses plus the selling expenses, whether direct or indirect, to determine your operating profit margin. Also known as your “earnings before interest and taxes” or EBIT.
Other types of profit margin you should know include the pretax profit margin, which essentially tells you how efficient your company is. Simply put, it refers to how many cents of profit you have for every dollar of sales your company makes. You might’ve also heard of the net profit margin, which is the ratio of your net profit to your revenue.
Understanding the different types of profit margins allows you to assess which factors hold back your potential profit margin increase. Whether it’s the direct costs of production, the indirect expenses for administrative expenses or marketing, or even taxes depending on where you operate.
2. It should not be steady
Profit margin is known as an indicator of a business’s health, giving you on-the-spot answers to questions like how much money you’re making or whether your pricing is fair and advantageous. More importantly, a profit margin increase is generally good, but you should not stop there.
As a business, you need to make sure that your profit margin continues to rise every year. It’s a metric you should keep on improving. In a Bloomberg Businessweek article, Doug Hall notes that if your profit margins are not increasing, there’s a chance that your business is not thriving. Sure enough, costs continue to rise and you wouldn’t want your revenue to stay stagnant or worse, be overtaken by your expenses.
3. Profit margin increase varies
This is a small fact that most entrepreneurs, especially small business owners, tend to overlook. You don’t just compare your sales values to a friend working in another state, and you definitely don’t compare with a neighboring shop that operates an entirely different business than yours. Understanding that profit margin varies based on a variety of factors will help you assess your own profit margin increase and give you a more realistic picture moving forward.
Take for example a net profit margin increase of 8%. If you’re in the consulting industry, this is exceedingly low since consulting companies can reach margins of 80% or more, sometimes even exceeding 100% in a year. However, if you’re operating a restaurant, that is already above average. Dining businesses usually keep profit margins below 10%, with values of 3% to 5% in their early years already considered a healthy indication.
4. Adopt best practices to increase profit margins
This is also something that some business owners tend to skip, especially since process improvements and implementing changes come with an upfront cost on top of the resistance to change some people just have. However, in the long run, this will benefit your business and could even reduce your operating expenses.
One example is improving inventory visibility, a practice that can be used for a wide range of businesses that use or store materials as a part of their operations. Keeping real-time information on the stocks you have on hand, as well as the schedule of your replenishment will help you make better decisions relating to sales and marketing. Usually, companies with poor inventory are forced to cut losses by selling these goods at a marked-down price.
5. Maximize your customers’ spending
At the bottom of it all, profit margins require more revenue, and you can do this by focusing on maximizing your customer spending on your business. By increasing the average order value, you can get more from your existing buyers. Common sales techniques that can help here are upselling and cross-selling. Upselling attempts to convince a buyer to switch to a higher-end version of a product they’ve previously purchased while cross-selling tries to sell products that offer added value or complementary purpose on top of the original product sold.
An example of this is suggesting other products depending on a buying decision. If you’re selling clothes and a customer purchases a pair of pants from your online shop, you can add a section that shows shoes or belts that go with it. This strategy is better suited for your existing buyers since they’re more familiar with your products and are more likely to explore your offerings more. This improved conversion rate could increase your sales, which in turn will increase your revenue, bumping your profit margins upward.
A profit margin increase is not something to be afraid of. More importantly, it’s not something you should be satisfied with and stop at. Continuously improving and trying to surpass your previous figures will keep your business relevant and thriving, which will lead your company to a better position.